Annex 1: Economic and Fiscal Outlook

Focus—Pipeline and Refining Capacity

Housing Market Pressures Easing

Following rapid growth in prices and sales in recent years, housing market conditions have become more balanced in Toronto and Vancouver, and their surrounding regions.

While price gains for all dwelling types have been robust in these markets over the past few years, price growth of single-detached homes has slowed recently. Price growth for other dwelling types—notably apartment condominiums—has remained strong. Tight supply conditions in these markets remain an important factor affecting prices. Meanwhile, housing activity in the oil-producing provinces had been soft but has picked up in recent months, while activity in the rest of the country remains positive (Chart A1.9).

Going forward, housing demand across the country should continue to be supported by solid job and income gains, but tempered by rising interest rates and recent changes to mortgage underwriting Guideline B-20 for federally regulated lenders (including a mortgage rate stress test for uninsured mortgages).

[Chart 1.9 - Text version]

Global Economic Developments

Global Economic Activity Is Firming

Internationally, economic momentum continues to strengthen. Following two consecutive years of deceleration, global growth finally accelerated in 2017, and was highly synchronized across regions with almost every part of the world registering growth. Building on this momentum, the pace of global economic expansion is expected to pick up further in 2018. In addition, the share of countries in recession is projected to decline to a record low (Chart A1.10).

However, the acceleration in global economic activity is expected to be somewhat constrained. While economic activity in emerging economies as a whole is expected to strengthen this year and next, most advanced economies are already growing faster than their estimated potential or trend growth rates, and thus as a group are not expected to accelerate further.

[Chart 1.10 - Text version]

Global Financial Conditions Remain Supportive Despite a Recent Pullback in Equities

Monetary policy continues to be very accommodative, with the policy interest rates of most major central banks remaining low and some central banks continuing to deploy extraordinary monetary policy measures to support economic growth, close output gaps and help revive inflation.

Equity markets, which rose over much of the past two years, have recently seen declines accompanied by a surge in volatility. While sudden, these declines brought most indices back to where they were late last fall. Moreover, the factors that have supported markets for most of the past year remain largely in place, including an improving global economic backdrop, rising expectations for corporate profits, still highly accommodative monetary policy, and investors’ continued search for yield.

Improving economic momentum is leading a number of central banks—most notably the U.S. Federal Reserve—to gradually increase their policy interest rates and reduce their extraordinary measures (Chart A1.11). In this context, some longer-term interest rates have risen modestly, though they remain near historic lows. As central banks continue to normalize monetary policy, interest rates are expected to continue to gradually rise.

[Chart 1.11 - Text version]

The U.S. Economy Is Operating at Potential

In the United States, the long recovery from the effects of the Great Recession appears to be complete. The U.S. economy has been operating near or even slightly above its potential in recent years, after almost a decade of running below its long-term trend level (Chart A1.12).

Alongside strong output growth, the U.S. labour market continues to strengthen, with solid job creation and steady gains in the employment rate of the 25 to 54 age group. The unemployment rate, at 4.1 per cent since October 2017, is at its lowest level since 2001. However, average hourly wages grew 2.5 per cent in 2017, broadly the same increase as in 2016. While wage growth has gradually trended higher since the end of the recession, the progression of both monthly and annual gains has been uneven.

[Chart 1.12 - Text version]

Looking forward, the U.S. economy could see improved growth in 2018. However, the U.S. federal government deficit is projected to grow to over one trillion dollars next year, or about 5 per cent of GDP. Over the coming months, the Department of Finance Canada will conduct detailed analysis of the U.S. federal tax reforms to assess any potential impacts on Canada.

European Economies Surprised on the Upside in 2017

Economic growth has also accelerated across the euro area, increasing from 1.8 per cent in 2016 to an estimated 2.5 per cent in 2017. This is more than two times faster than the estimated potential growth rate of about 1 per cent for the euro area as a whole. Further, high-frequency indicators suggest a continuation of strong growth in early 2018 (Chart A1.13), and the IMF expects the pace of euro area growth to remain fairly elevated, at 2.2 per cent this year. This should result in the continued absorption of remaining economic spare capacity across euro area countries.

[Chart 1.13 - Text version]

In the United Kingdom, growth slipped from 1.9 per cent in 2016 to 1.8 per cent last year, and is expected to continue to gradually slow over the near term. Weak consumer confidence and business investment, along with uncertainty related to the UK’s future trade relationship with the European Union (EU), should weigh on UK growth.

Canada is well placed to benefit from the steady economic activity in Europe. The Comprehensive Economic and Trade Agreement (CETA), which entered into force on September 21, 2017, eliminates virtually all tariffs on goods between Canada and the EU. The agreement gives Canadian exporters new access to one of the world’s largest single markets—at $21.8 trillion, the EU represents 22 per cent of global GDP, with half a billion consumers.

Strong Growth in China and Emerging Economies

Among the major emerging economies, overall growth firmed in 2017. This was largely due to recessions ending in Brazil and Russia, rather than a marked acceleration of growth in other emerging nations.

Nonetheless, growth among emerging economies is expected to continue to increase in 2018, mainly reflecting a pick-up in growth in Latin America and the Middle East, in part attributable to firmer commodity prices. In addition, a rising rate of economic expansion in India will further support the overall rate of growth in emerging economies (Chart A1.14).

However, a number of emerging economies remain vulnerable to sudden shifts in capital flows that could be triggered by an unexpected sharp appreciation of the U.S. dollar or a global repricing of risk. This is particularly true for countries with significant amounts of U.S.-dollar-denominated debt.

In China, growth is expected to continue to gradually slow in 2018 and beyond. However, China will continue to grow faster than most other countries, and faster than expected one year ago. Economic activity is expected to be supported by stronger external demand, and economic reforms and deleveraging are taking place very gradually to reduce the risk of an abrupt growth slowdown.

[Chart 1.14 - Text version]

Canada has gained important new market access into the fast-growing Asia-Pacific region. On January 23, 2018, Canada was among the eleven countries that successfully concluded negotiations on the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). This agreement will provide access to markets totalling $11.5 trillion, representing 12 per cent of the global economy and over 450 million consumers. This includes key markets such as Japan, Malaysia and Vietnam—representing $9.7 trillion in GDP—with which Canada has no existing preferential trading relationship. Nearly 87 per cent of tariffs faced by Canadian exporters will be eliminated upon the entry into force of the CPTPP, with most remaining tariffs to be eliminated within 15 years.

Budget 2018 Economic Outlook

The economic and fiscal projections contained in this budget are based on the December 2017 survey of private sector economists. Details of the full private sector economic outlook are presented in Annex 2.

In summary, economists expect real GDP growth of 3.0 per cent in 2017, the same rate as in the 2017 Fall Economic Statement but significantly higher than the 2.1 per cent originally projected in Budget 2017. The outlook for real GDP growth is slightly improved for 2018 but little changed thereafter (Table A1.1). The outlook for GDP inflation (the broadest measure of economy-wide price inflation) has been revised down in both 2017 and 2018 compared to the 2017 Fall Economic Statement forecast. Going forward, the outlook for GDP inflation is broadly in line with the previous forecast.

As a result, expectations for growth in nominal GDP—the broadest measure of the tax base—have been revised down for 2017 (from 5.5 per cent to 5.2 per cent), but are largely unchanged thereafter. The level of nominal GDP over the projection horizon is $4 billion lower per year, on average, than was anticipated in the 2017 Fall Economic Statement, but still more than $20 billion higher than projected in Budget 2017.

Risk Assessment

While the global and Canadian economies have evolved largely as expected since the Fall Economic Statement, both upside and downside risks remain which could affect the economic outlook. In particular:

• Stronger and more durable growth in the global economy than currently expected would benefit Canadian economic activity.
• Household spending and business investment in Canada could continue to surprise on the upside given elevated business and consumer confidence, tightened business capacity and labour market conditions, and rising wage growth.
• As global oil markets continue to move closer to balance, oil prices could be higher than expected in the medium term. Higher-than-expected demand for oil with more significant supply constraints in the future, reflecting recent cuts in global oil and gas investment, could tip the balance towards higher oil prices, benefitting income and investment in Canada. However, a persistent or widening gap between Western Texas Intermediate and Western Canada Select crude oil prices could partially erode this benefit.

At the same time, there are a number of downside risks to the outlook.

• Uncertainty regarding the outcome of North American Free Trade Agreement negotiations as well as a notable shift towards more protectionism globally could impact Canada.
• As some advanced economy central banks, such as the U.S. Federal Reserve, continue to normalize monetary policy, financial conditions could tighten faster than anticipated, especially as they have remained surprisingly favourable over the past year. Tighter-than-expected financial conditions could create turbulence in world financial markets, especially in the context of elevated market valuations, although the recent pullback in global markets has relieved some pressure. This would affect Canadian businesses and households through a combination of higher interest rates, negative wealth effects and/or lower confidence.
• High household debt remains a key domestic vulnerability for Canadian consumption and housing activity in the case of a large shock to income, house prices or interest rates.

Overall, the risks to the December 2017 economic outlook are broadly balanced in the short term, and continuing engagement with survey participants has confirmed that the outlook is an appropriate basis for fiscal planning. Budget 2018 includes an adjustment for risk of $3.0 billion in 2018–19 and future years to account for risks and uncertainty in the economic and fiscal forecast.

Budget 2018 Fiscal Outlook

Baseline economic and year-to-date developments since the 2017 Fall Economic Statement (FES 2017) have improved the outlook for the budgetary balance over the forecast horizon, by an average of approximately $3.3 billion per year. A detailed summary of changes to the fiscal outlook since FES 2017 is provided in Annex 2.

Continued Investments in a Strong Middle Class

Budget 2018 builds on the Government’s previous actions, and proposes smart, targeted investments that will help create the conditions required to foster economic growth and provide more opportunities for the middle class. The fiscal implications of developments since FES 2017, including the costs of Budget 2018 proposals, are shown in Table A1.2 below.

A Downward Deficit and Debt Ratio Track

Growth-generating investments in people, in communities and in the economy are balanced by sound fiscal management. The federal debt-to-GDP ratio is projected to decline gradually over the forecast horizon, reaching 28.4 per cent in 2022–23. According to the IMF, Canada’s net debt-to-GDP ratio is by far the lowest among G7 countries and less than half the G7 average (Chart A1.15).

[Chart 1.15 - Text version]

The Budget 2018 fiscal track continues to show steady improvements in the Government’s annual budgetary balance, which is nearly $7 billion lower annually, on average, than projected in Budget 2017.

[Chart 1.16 - Text version]

The Government will maintain this downward deficit and debt ratio track. Low debt levels support economic growth and intergenerational equity by keeping interest costs low and preserving flexibility to face future economic shocks and challenges.

Continued Economic Strength Would Accelerate Deficit Reduction

The fiscal projections presented in this budgetare based on an average of the December 2017 private sector economic outlook survey. However, economists surveyed offered a wide range of views regarding future economic growth and, therefore, the path of nominal GDP (the broadest measure of the tax base). Changes in economic growth assumptions can also have large impacts on the budgetary balance and debt-to-GDP profile over an extended projection horizon.

For example, if the Government based current fiscal projections on the average of the top four individual forecasts for nominal GDP growth—which is equivalent to nominal GDP growth being 0.3 percentage points per year higher, on average, than in the full survey—the budgetary balance would improve by $3.0 billion per year on average (Chart A1.17).

[Chart 1.17 - Text version]

Conversely, basing fiscal projections on the average of the bottom four individual forecasts for nominal GDP growth—which is equivalent to nominal GDP growth being 0.3 percentage points per year lower, on average, than in the full survey—the budgetary balance would worsen by $3.5 billion per year on average, and the federal debt-to-GDP ratio would still decline, but be 1.2 percentage points higher than projected in 2022–23.

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¹ Unemployed for 27 weeks or more.