Record Canadian GDP growth and strongest US GDP growth since 1984 are expected in 2021.
Strong momentum observed across a range of variables early in 2021 despite the spike in the number of new COVID-19 cases observed internationally.
Even with the high likelihood of another wave in the pandemic, risks to the outlook seem tilted to the upside.
The Federal Reserve and Bank of Canada may need to raise interest rates more rapidly than in their most recent guidance of 2024 in the US and 2023 in Canada.
Another month, another upward revision to our forecasts. While COVID-affected sectors generally continue to struggle given restrictions on activity, most other sectors are showing considerable vigour. The global economy is on track to record its most rapid pace of expansion in at least 40 years, thanks in large part to US fiscal policy. This optimism and the upside risks to the outlook remain in place, despite our anticipation of at least one more wave of COVID-19 arriving in the coming weeks.
The expected vigour in the United States is nothing short of astounding. A rebound from the pandemic was always expected to lead to solid growth this year, but the stimulus cheques paid early in January and the $1.9 trillion American Rescue Plan will turbo-charge the recovery. In this update, we are revising our forecasted growth in the US to 6.3% in 2021 and 4.4% in 2022. This would be the strongest growth, by far, since 1984 and would see US economic activity in 2022 exceed where it would have been had pre-COVID trends been maintained. This is the only country in the world where this is expected. Moreover, risks are tilted to the upside. In line with the past experience with transfers, we assume very low multipliers on planned fiscal expenditures given the fact that they are mostly transfers to individuals. That may prove overly pessimistic given the surge in retail sales seen in January, shortly after the $600 cheques were mailed out. Moreover, President Biden has made it clear he wishes to launch an infrastructure program later in the year which could, at the margin, further boost growth this year and next.
The speed of the recovery, if eventually confirmed by the data, continues to suggest that the Federal Reserve may need to tighten interest rates sooner than publicly communicated. While we do not believe inflation will rise in an uncontrolled manner, we anticipate core PCE will rise to 2.4% y/y by the end of 2022. The steepening of the yield curve is roughly consistent with this view at present, though we expect additional but more gradual steepening in the quarters to come. The move observed thus far is, in our view, entirely consistent with the improvement in the outlook and does not represent a headwind to growth.
Canada stands to benefit from the US rebound directly, but also indirectly through the increase in financial assets and commodity prices seen in recent months. Relative to our earlier expectations, the rise in commodity prices is quite spectacular. We expect a gradual pullback from current levels as supply adjusts to the strength of demand across almost the full range of commodities. Even so, commodity prices would be highly supportive to the Canadian outlook and should, on average, be well above our previous forecasts.
Adding to these external factors, we are seeing further signs of resilience in retail sales in our internal tracking of transactions which suggests to us that consumption will advance sharply this year (March 4th issue is available here). This will of course be supported by strong job growth, wealth effects from housing and equity markets, government support programs, and strong household balance sheets. Similarly, housing construction is off to a strong start this year and January building permits are pointing to a potentially record increase in residential investment this year. Housing-related activity should also remain strong given low mortgage rates and the shortage of supply relative to demand as already seen so far this quarter. One risk to the outlook on this front: record low levels of homes for sale could prove to be a headwind to sales in the weeks and months to come.
We assume a third wave of the virus will hit Canada by early April. There are likely to be some additional containment measures that result from that. Given the experience with the second wave and the resilience of a range of economic variables to strict containment measures, we assume this third wave would have only a modest impact on second quarter GDP, shaving only about a percentage point from annualized growth. This would lead to quarterly GDP growth of 5.0% in 21Q2. This may well prove to be an overly optimistic judgement, but we are learning by doing: we had originally forecast a decline of 2.1% in 21Q1 and our tracking now suggests a lift of 4.5% q/q given the strength seen in incoming data. We now forecast growth of 6.2% this year and 4.0% next year.
We expect that progress on the vaccination front will allow a broader lifting of containment measures in the second half of the year. Should that occur, the recovery baton will pass to the sectors currently most affected by COVID. A surge in activity in the tourism, arts and entertainment, and food and accommodation sectors is likely. There is already clear evidence of pent-up demand for these services.
As is the case in the US, we don’t think the Bank of Canada will wait until 2023 to raise interest rates. As currently measured, we think the output gap will be closed by the end of this year and that Canada will recover output lost to the pandemic by the third quarter. Core measures of inflation should gradually rise to the Bank of Canada’s 2 per cent target by the end of the year and peak at 2.3% by the end of 2022 if they raise interest rates in the second half of 2022.
Though we believe upside risks to the forecast dominate, we cannot exclude the possibility that mutations of the virus throw the recovery off track, nor can we discount challenges associated with vaccine rollouts in Canada. These are material downside risks to our view. Likewise, our call that a third wave would have limited economic effects could well be overly optimistic. Looking further ahead to 2023 or 2024, there is a risk that the US overheats by then, creating imbalances that may be problematic in these outer years. That may well be a good problem to have given the experience of the last year.
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