The Owl
The Weekly Wrap, April 19, 2024
Cooling core inflation and the need for investment
By Mark Parsons, ATB Economics 19 April 2024 7 min read
In this week’s ATB Economics Weekly Wrap…
- Weak business investment has hurt national productivity
- Cooling down: Core inflation
- Heating up: Home construction in Alberta
- National tourism week - reason to celebrate
- What’s your term? Why higher interest rates impact countries differently
- Federal Budget 2024
- Interesting Fact: Bitcoin halving
- Chart of the Week: Explaining Alberta-Ontario migration patterns
Why has labour productivity slowed in Canada?
In her “break the glass” speech, Senior Deputy Governor Carolyn Rogers explores the various factors that have contributed to weak productivity in Canada. One of them was business investment, which remains well below 2014 levels (adjusted for prices).
But how much is investment weighing on labour productivity? In data released this week, Statistics Canada helps answer the question. The agency decomposes labour productivity growth into its various sources since 1980:
- Capital intensity. Giving workers more capital investment (e.g. machinery) to work with.
- Labour composition. Improving the skills and training of the workforce.
- Multifactor productivity. Better, or more efficient, use of both capital and labour.
Of the three factors, Statistics Canada finds that sluggish business investment largely accounts for the productivity slowdown since 2015.
Digging deeper, the C.D. Howe has showed that the investment per worker gap has widened between Canada versus the U.S. and other OECD countries, especially since 2015. The Canada-U.S. gap is particularly wide for machinery and equipment and intellectual property.
What about 2023? Statistics Canada hasn’t yet provided a decomposition. But we do know that labour productivity fell significantly last year (by 1.5%), and real business investment edged lower (by 0.6%).
Business investment is one key part of the productivity puzzle. Solving it would go a long way towards improving living standards and wages for workers.
The slowdown in productivity growth in Canada between 2015 and 2022 is primarily due to weak business investment
Last year, real business investment in Canada remained more than 10% below its 2014 peak
The core is cooling - just what the BoC was looking for
It’s tempting to dismiss a lower ‘core’ inflation reading as an aberration. But we’ve had a few of them lately, and that’s exactly what Governor Tiff Macklem said he wanted.
Sure, headline inflation was higher last month due to gasoline. But core inflation (which strips out more volatile price movements) is unambiguously trending lower. And it’s not just a function of the year-ago levels. On a month-over-month basis, median and trim measures of core prices rose by less than 1.5% (3-month moving average, annualized). Excluding shelter costs, annual inflation was 1.5% last month.
Does this make a June interest rate cut a slam dunk? No, but it remains our base case view. There’s still one more inflation print before the June decision. If the April core reading shows further progress, it could be hard for the Bank to justify yet another (seventh straight) pause.
That said, it will be interesting to see how patient the Bank is. It could wait until July with a fresh set of forecasts. That will buy it more time to collect more data, and likely bring them closer to the U.S. Federal Reserve first cut (looking more like July or September these days). But it’s also a risk, potentially leading to more economic weakness than necessary to get back to the 2% target.
The national inflation rate excluding mortgage interest costs fell to 2% in March while core measures hovered near 3%
Heating up: Alberta home construction
An influx of migrants has put pressure on Alberta’s housing market. Home inventories are falling and prices are rising. Fortunately, builders have stepped up to the plate as of late.
Housing starts averaged 45,154 units (seasonally-adjusted at an annual rate) in the first quarter, 58% above last year and the highest quarterly average in nearly a decade. Construction of all types of dwellings rose last quarter, with multi-dwelling units leading the charge. Residential permits have also picked up steam.
Given last year’s jump in population, we see ‘catch-up’ construction continuing. In our March outlook, we upgraded our 2024 Alberta housing starts forecast to 41,000. With the recent momentum, that’s starting to look a tad conservative.
It’s National Tourism Week in Canada
It’s been a long road for tourism, an industry decimated by COVID disruptions.
The good news is that demand has come roaring back. Foreign traveler spending in the third quarter of 2023 reached a record high in Alberta. Non-resident visitors entering Canada via Alberta now exceed pre-pandemic levels. See our recent update: Travel’s back alright!.
Some challenges remain, like labour shortages (the job vacancy rate in food and accommodation was 8.3% in the third quarter of 2023 - higher than any other industry), and rising food costs.
Term matters - why some countries are sensitive to rate hikes
The U.S. economy has stayed strong despite higher interest rates, while Canada’s economy has slowed to a crawl despite a much faster growing population.
Why the difference?
One factor is that Canada is more sensitive to interest rates. Household debt ratios are much higher in Canada, making the country vulnerable to rate changes. Mortgage terms are also much shorter here (in the US a 30-year term is common), leaving more borrowers more exposed to rising rates in the near term.
In a recent study, the International Monetary Fund compares how different mortgage arrangements impact a country’s response to interest rates. It finds that economies (like Canada) with a lower share of fixed, long-term mortgage terms are more impacted by higher interest rates in the near term. Higher debt ratios also increase the speed of transmission.
But, as we have seen, the differences extend beyond rate sensitivity, with Canada’s sluggish productivity and business investment performance weighing on economic activity.
The Federal Budget 2024
Released on Tuesday, Federal Budget 2024 estimates a deficit of $40 billion in 2023-24, easing slightly to $20 billion in 2028-29. Deficits are cumulatively higher by $10.2 billion over the next 5 years relative to the fall economic statement, despite a stronger forecast for the tax base (as measured by nominal GDP).
New spending of $53 billion since the fall statement is heavily focused on housing, and partly offset by revenue measures. Noteworthy was a $5 billion indigenous loan guarantee program (importantly this applies to all sectors, including energy projects), similar to the Alberta Indigenous Opportunities Corporation created in 2019.
To pay for new spending, the capital gains tax inclusion rate will increase. See this summary of the tax changes by ATB Wealth.
Responding to the Budget, the Business Council of Alberta acknowledged progress with the indigenous loan program, stated efforts to streamline project approvals, and labour (immigration/credentialing) measures, but raised concerns about economic impact of new taxes. While some have argued that the higher capital gains inclusion rate improves equivalency with other forms of taxation (dividends, wages), concerns have been raised that it could hinder efforts to address the country’s investment and productivity challenge.
Interesting Fact: Miners currently receive 6.25 Bitcoins for each block mined, a figure set to decrease to 3.125 Bitcoins soon. This reduction occurs every 210,000 blocks, with the next halving expected between April 18 and 21 this year. The halving aims to control inflation algorithmically by slowing the creation of new Bitcoins.
Confused? You’re not alone. Miranda Mantey breaks all this down in Thursday’s Owl
Chart of the Week: Recent Alberta-Ontario Migration Patterns
We have embarked on a three-part series on the dramatic increase in interprovincial migration to Alberta since mid-2022.
In Part 1, we recapped what has happened overall. In Part 2, we explored the second largest source of gains to Alberta - migrants from B.C. Today, we look at the largest source of inflows, which is from Ontario.
Alberta has long welcomed migrants from Ontario. The net-inflows have been fairly persistent, occurring in three-quarters of the last 52 years. Since 1972, Alberta has gained 262,000 residents cumulatively from Ontario, including over 23,300 in 2023 alone.
There are only two periods when Alberta experienced sustained outflows to Ontario - the mid-1980s and 2015-2020, the latter period being much milder period of out migration. Both were marked by slowdowns in Alberta’s economy and labour markets.
The largest wave of in-migration from Ontario came in the late 1970s/early 1980s, then again during the Alberta energy booms of 2004-2008 and 2011-2014. These movements can largely be explained by relative labour market conditions. In all these periods, Alberta’s labour market was much tighter, as reflected by unemployment rate differentials.
The latest influx of migrants from Ontario looks different. Job growth has been stronger in Alberta over the last two years, but the Alberta unemployment rate has only recently nudged below Ontario’s.
More important this time around is affordability - particularly housing affordability. The gap between Alberta and Ontario housing prices widening after 2015, with rising interest rates stretching affordability ratios further. As shown in our Chart of the Week, while the gap is closing, estimated mortgage to income ratios (and rents) remain much higher, on average, in Ontario than in Alberta.
A narrowing of the unemployment rate differential, and much stronger job growth in Alberta, has contributed to inflows from Ontario in recent quarters
Alberta’s housing affordability advantage relative to Ontario is one of the major reasons behind the strong inflow of interprovincial migrants seen from Ontario to Alberta over the last two years
Answer to the previous trivia question: Alberta had the highest level of overall labour productivity among the provinces in 2022, followed by Saskatchewan and Newfoundland & Labrador.
Today’s trivia question: Alberta is home to what percentage of Canada’s beef cows?
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