Real GDP growth increased a robust 4.0% in 1997 before slowing to 3.1% in 1998. Growth in the second and third quarters of last year was held back by strike-related disruptions in many important industries (for example, the GM auto strike in the U.S., labour unrest in southern Ontario’s construction industry, and the Air Canada strike). However, output surged 4.6% (annual rate) in the fourth quarter, due in part to inventory accumulation and a strong export performance. This momentum carried forward into 1999, with real GDP increasing 4.2% in the first quarter. Consumer spending, housing and business investment, and strong exports (to the U.S.) all contributed to this performance.

Looking ahead, the consensus forecasts calls for real GDP to increase slightly in 1999 (to 3.2%), before falling off slightly in 2000 (to 2.6%). This forecast represents a dramatic improvement as compared to the outlook at the end of last year. Continued strength in the U.S. and the improved position of many Asian economies has brightened the overall outlook for Canada.

Consumer demand grew 4.2% in 1997, but fell to 2.8% in 1998. After posting a very strong second quarter (largely financed through lower savings), consumer expenditures slowed in the last half of the year, registering no growth in the final quarter of 1998. However, buoyed by a surge in purchases of big-ticket items, consumer expenditures advanced 5.1% (annual rate) in the first quarter of 1999. Looking ahead, there is some concern over Canada’s rising debt-to income ratio and low savings rate. As a result, the consensus forecast calls for slowing growth in personal expenditures in 1999. This forecast could be revised upwards if employment growth picks up later in the year.

Business investment in machinery and equipment (M&E) was quite strong last year, posting 9.5% growth in 1998. This was spurred in particular by strong investment in computers and other office equipment. Elsewhere, investment in non-residential construction remained virtually unchanged in 1998 after posting a robust 14.0% gain in 1997. Looking ahead, several factors suggest that growth in real fixed business investment will remain healthy but nonetheless slow from the fast pace of the previous two years. In the first quarter of 1999, M&E investment advanced 8.9%, but growth in non-residential construction declined 1.1% (still its best performance in a year and a half).

Residential construction declined in 1998, with housing starts falling an estimated 7% in 1998. Several factors contributed to this decline, including lower immigration, declining consumer confidence, and regional factors such as a lengthy builders’ strike in Ontario. However, the new year began on a very positive note, with investment in housing rising 16.6% (annual rate) with strength in new housing, renovations and resales. Despite the solid first quarter in 1999, the Canadian Mortgage and Housing Corporation forecasts housing starts to stabilize in 1999 before increasing in 2000. Historically low mortgage rates, combined with further expected gains in personal disposable income, are expected to support activity in 1999. Finally, renovation activity is expected to be boosted by the relatively high housing resales over the past few years.

International trade was a major source of growth for the Canadian economy in 1998. Real export growth was 8.2% in 1998, slightly below the performance in 1997. On the other hand, after increasing 14.6% in 1997, real import growth slowed to 5.8% in 1998. Canada’s exports have been sustained by the strong American economy, which now accounts for approximately 85% of total Canadian exports. Exports to Asia decreased sharply in 1998, with the significant decline in commodity prices hitting key export-oriented industries such as forestry, farming and mining. Since Canada is a net exporter of these products, the plunge in commodity prices led to a deterioration in Canada’s terms of trade, and a fall in Canada’s trade surplus on a nominal basis.

The strong U.S. economy boosted Canada’s trade sector early in 1999. Export growth (8.5%) more than doubled import growth (4.2%) in the first quarter of the year, leading to a significant improvement in Canada’s trade surplus. Early indicators suggest that net exports will continue to contribute to overall GDP growth in the upcoming year.

Foreign direct investment (FDI) in Canada exceeded C$217 billion in 1998, a gain of more than 10% from 1997. Most of this investment continues to be sourced from the United States, which accounted for nearly 70% of the total FDI stock in 1998 (up from 64% in 1990). However, over this time frame the proportion of FDI in resource-based industries has dropped, falling from 30% in 1990 to 26% in 1998. The largest gains have occurred in services and retailing (from roughly 7.5% to 9.5%) and other industries (from 29.5% to 31%). The proportion of FDI in finance and insurance sectors has remained largely unchanged this decade, accounting for 19% of total FDI in 1998.

Canadian Direct Investment Abroad (CDIA) continued to grow at a substantially faster rate than FDI, reaching nearly C$240 billion in 1998 and increasing by over 16% from the previous year. There has been a significant trend in the industrial distribution of CDIA toward the finance and service sectors (up from 37% in 1990 to 44% in 1998). There has also been a dramatic shift in the geographical location of investment away from traditional destinations and increasingly towards non-OECD countries. Although nearly 53% of CDIA in 1998 was to the U.S., this was down 8.5 percentage points from 1990. CDIA in non-OECD countries rose by roughly 10 percentage points to 23% over this same period.

Since 1991, the Federal Government and the Bank of Canada have jointly announced an official target range for the inflation rate. This target range has been gradually lowered since it was first announced and presently stands at 1% to 3%. In February 1998, the commitment to maintain inflation within the 1% to 3% target range was extended until 2001. The appropriate long-run target for monetary policy will be determined by the end of 2001.

Despite a lower exchange rate, inflation was contained in 1998, partially as a result of the collapse in world commodity prices. For 1998 as a whole, the annual average of the all-items consumer price index (CPI) increased 0.9%. With the exception of 1994 (when inflation was low due to a large cut in tobacco taxes), this is the lowest annual rate of inflation since the mid-1950s. In addition, the core inflation rate–which excludes the volatile food and energy prices as well as indirect taxes–remained within the lower half of the bank’s target throughout 1998. The consensus forecast calls for consumer prices to rise by 1.3% in 1999 and 1.6% in 2000.

Employment increased by 453,000 in 1998, the best year so far this decade for job creation. Moreover, two-thirds of the jobs created in 1998 were full-time positions. After beginning the year at 8.5%, the unemployment rate fell steadily through much of the year, reaching 7.8% by January 1999. However, thus far this year, the employment picture has softened. In the first six months of 1999, employment has only increased by 76,000 jobs, with the public sector (most notably health, social services and education) and manufacturing offsetting losses elsewhere. Self-employment has remained virtually unchanged throughout 1999.

Canadian residents continued to spend more than they earned abroad on goods, services, investment income and transfers in 1998. After posting an exceptional surplus of C$4.5 billion in 1996, the current account deficit widened throughout 1997 and 1998, with a deficit of C$16.4 billion (or 1.8% of GDP) last year. A falling surplus in the trade on goods (in nominal dollars) was responsible for the widening deficit. Although domestic demand for imports slowed in 1998, it still slightly outpaced growth for exports. Elsewhere, the deficit in services narrowed in 1998 (largely due to an improvement in the travel account) while the deficit on investment income reached C$30.2 billion (approaching the record level set in 1995).

In the first quarter of 1999, the current account narrowed substantially to C$5.4 billion (SAAR)–its best result in two years. This improvement was due to a sharp rise in Canada’s merchandise trade surplus ($30.8 billion). Elsewhere, the deficit on trade in services fell to an 11-year low, while Canada’s deficit on investment income increased slightly. Looking ahead, the consensus forecast anticipates the current account deficit to average C$9.8 billion in 1999 and C$7.8 billion by 2000.

After a 50 basis point hike in the bank rate in January 1998, official interest rates remained steady until the Bank of Canada intervened in August to shore up investor confidence in the Canadian dollar. Plunging commodity prices and the Asian crisis caused a substantial decline in the Canadian dollar, which posted a series of all-time-record lows in August. As a consequence, the Bank of Canada increased the bank rate a full percentage point (to 6.0%) on 27 August 1998. However, the Bank of Canada subsequently made five separate 25 basis point cuts over the September 1998 to May 1999 period, more than reversing the 100 basis points increase of August 1998.

Long-term interest rates continued to decline more or less steadily in 1998 in line with the strong fundamentals in the economy, and briefly stood at historically low levels, but have risen along with the US rates so far in 1999.

The Canadian dollar is a freely floating currency. However, the central bank will occasionally intervene to ensure orderly market conditions prevail.

As did many other currencies, the Canadian dollar encountered intense selling pressures through much of July and August of last year. Indeed, the dollar closed at an all-time low of US63.31¢ on 27 August 1998, down nearly eight full cents from its recent peak in March. The Canadian dollar’s weakness stemmed from political and economic instability in the Asian economies and elsewhere, which prompted a flight of international capital to the "safe haven" US dollar. The Asian crisis also slashed the demand for and prices of commodities, which added to the pressure on the currency as there was a widespread view that it was closely linked to commodities.

The Canadian dollar has gradually recovered, trading above the US69¢ barrier early in May. The dollar has been supported by an improved outlook in the Asia-Pacific region, which has led to a modest firming in commodity prices (particularly crude oil).

At the federal level, the budget was in the black for the first time since 1969, with a surplus of C$3.5 billion recorded in the fiscal year 1997-98. In February 1999 the federal government announced that a balanced budget would be achieved for 1998-99, representing the first time in nearly 50 years that the federal government has posted back-to-back balanced budgets or better. Furthermore, the federal government projects balanced budgets or better for the next two fiscal years. With these results, the federal debt-to-GDP ratio will fall from a peak of 71.9% in 1995-96 to 61.7% by 2000-01.

Canada’s provincial governments have also made substantial progress toward balancing their budgets. Seven provincial governments–Prince Edward Island, New Brunswick, Nova Scotia, Quebec, Manitoba, Saskatchewan and Alberta–have already announced intentions to balance their budgets in this fiscal year.

Canada has a somewhat stricter definition of the balanced budget than do most other large industrial economies. Indeed, Canada’s measure of financial requirements corresponds more closely to the deficit/surplus measures used in these economies. Under this definition, the federal government had a financial surplus of C$12.7 billion in 1997-98 (or 1.5% of GDP). Furthermore, sizeable surpluses are expected over the next three years.

Canada’s near-term economic prospects remain solid. The most recent consensus forecast calls for real GDP to increase by 3.2% in 1999 and 2.6% in 2000. This forecast represents a considerable improvement as compared to estimates towards the end of 1998. At the beginning of the year, the consensus forecast had called for real GDP growth of only 2.0% in 1999, more than a full percentage point lower than the current forecast. Forecasters are now more optimistic as Asian economies continue to improve, the US economy is still displaying continued strong growth, and there has been a firming in commodity prices.

Source: Data are as submitted by member economies, unless otherwise specified.

Table 2. Forecasting Summary (% change from previous year)

Note: The official forecast refers to the private sector consensus forecast. The IMF forecast is from the World Economic Outlook (IMF, April 1999). The OECD forecast is from the OECD Economic Outlook (OECD, June 1999).