April 16, 2014 / 12:48 PM / 4 years ago

Household debt overhang holding back Canada's economy

(Reuters) - Canada’s economy will grow only modestly over the next two years and underperform the United States as high household debt levels and a cooling housing market restrain consumer spending, a Reuters poll found.

By contrast, economists predict that a long-awaited pick up in exports will take hold in the second half of this year as the Canadian dollar weakens and the United States, its top trading partner, recovers further.

The Canadian economy will grow 2.3 percent this year and 2.6 percent next year, according to the median forecast of 33 economists surveyed for Wednesday’s poll.

Those predictions are almost unchanged from January’s poll and lower than forecasts for the United States, which is expected to grow 2.7 percent in 2014 and 3 percent in 2015.

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The Bank of Canada estimated growth of 2.5 percent in both 2014 and 2015 in January, but it might tweak those numbers in its quarterly report on Wednesday.

Economists lowered their forecast for annualized growth in the first quarter of this year to 1.7 percent from 2.2 percent in January’s poll. Forecasts for the remaining quarters of this year and the first half of next year were nearly unchanged.

“We don’t have much potential on the domestic side, at least in the near term, to move our economy at a rapid rate owing to elevated household debt and a cooling housing market,” said Sal Guatieri, senior economist at BMO Capital Markets.

Consumer spending, and in turn, domestic demand, has been one of the main reasons why Canada’s economy recovered more quickly from the financial crisis than the United States.

That demand was mostly due to a housing boom, which was fuelled by record low borrowing costs. Unlike in the United States, which suffered a punishing property market crash, Canada’s housing market has moved in a straight line up for many years.

But the housing market is now cooling down, and a few market watchers are still concerned about risks of a U.S.-style crash. Along with lofty household debt levels, that has made the Canadian consumer more cautious about spending.

Indeed, Canada’s disposable household debt-to-income ratio is at a near-record high of 164.0 percent. By contrast, U.S. households reduced their indebtedness in the wake of the crash.

Economists in Wednesday’s poll expect Canada`s housing market to continue to cool. They predicted construction will begin on 176,700 homes this year, down from the 181,300 they forecast in January.

Forecasters expect that number to decrease further to 172,000 homes next year, compared with the 180,200 predicted three months ago.

Canadian housing starts reached an annual pace of more than 200,000 in the rate-fueled boom that followed the financial crisis. Housing starts have already slowed down to 156,823 in March.

Still, most are not worried about an outright crash.

“We still see that as a low probability risk at this point. You’ve got to think of it in terms of what would trigger that and there’s no major catalysts at this point,” said Mazen Issa, senior Canada macro strategist at TD Securities.

A significant hike in the Bank of Canada’s key interest rate from the current 1.00 percent and a sudden drop in employment would be two triggers, Issa added. He doesn’t expect either to happen.

Inflation will climb up to 1.9 percent next year, a touch away from the central bank’s 2 percent target, the poll showed. Still, a separate survey taken earlier this month found the bank is not likely to hike its key interest rate until the third quarter of next year. <CA/POLL>

The best prospect for the Canadian economy is an exporter revival, which is expected to take place over the next two years as stronger U.S. economic growth leads to increased demand for Canadian goods - including energy, automotive and mineral exports.

A weaker Canadian dollar will also help by boosting exporters’ sales in local currency terms. A Reuters poll conducted early this month found foreign exchange strategists expect the currency to weaken over the next 12 months.

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Polling and additional reporting by Ishaan Gera; Editing by Jeffrey Hodgson and W Simon

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