Regional divergences continue in Canada

The Canadian dollar slipped below 75 US cents for the first time in 11 years this week. Since the freefall began in mid-2014 alongside the plunge in oil prices, the loonie is now down by nearly 20%. The weakness this week was triggered in part by market reaction to an unexpected interest rate cut in Norway, which is a fellow oil-producing country, and messaging from its central bank that further monetary stimulus may be required.

This, however, is unlikely the case for Canada. The Bank of Canada has cut interest rates twice already this year, and the current level of stimulus appears to be appropriate. While the Canadian economy contracted during the first half of the year, it expanded in June (+0.5% m/m), and Q3 data released so far have been relatively positive. Most recently, retail sales data for July showed a 0.2% increase in real terms, which bodes well for overall growth during the month. In fact, the economy is on track to advance at a 2-2.5% (annualized) clip during the third quarter, which is ahead of the Bank of Canada's latest forecast of 1.5%.

However, these headline numbers mask a large degree of divergence across the country. Oil producing regions continue feel the pain inflicted by lower oil prices, with real GDP in Alberta, Saskatchewan and Newfoundland and Labrador forecast to contract this year. Earnings data released this week reinforced this notion, as average weekly earnings declined 1.5% (y/y) in Alberta, extending the downward trend that began in February. Declines in July were due to both job losses and wage decreases in the energy sector. In Saskatchewan and Newfoundland and Labrador, weekly earnings growth has also been trending down over the course of this year. In contrast, earnings in Ontario and B.C. recorded gains of over 2% (y/y) and have been holding up much better than the oil-producing regions.

This divergence is also reflected in consumer spending patterns. For example, in August auto sales fell in Alberta (-13% y/y), Saskatchewan (-9% y/y) and Newfoundland and Labrador (-4.3% y/y), worsening the year-to-date declines. Meanwhile, auto sales in B.C., Quebec and Ontario are up solidly this year.

Looking ahead, challenges will remain for the oil-rich provinces. While oil prices are expected to gradually move higher, the level of prices will remain quite low relative to what producers have been accustomed to in recent years. Indeed, we don't expect WTI to get back to US$70 per barrel before the end of 2017. While a weaker loonie - which we expect to bottom at 73 US cents in the first quarter of 2016 - will continue to cushion the blow, the lower for longer price environment will limit capital spending in these provinces - which has been a key source of growth in recent years - as well as income gains. As such, even with a return to growth in Saskatchewan and Alberta next year, these economies are expected to advance at a sub-2% pace in 2016 and 2017 - roughly half their cruising speeds coming out of the last recession. Newfoundland and Labrador is expected to only stabilize by 2017.

Fortunately, other regions are poised to do well, particularly those tied to non-energy exports. Canada's export sector has finally started to gain steam - a trend that we expect to continue going forward, aided by the lower loonie and strengthening U.S. economy.