Business Outlook: CANADA
A LOT IS RIDING ON THE WILD CARD: QUEBEC
Canada took another step toward recession last quarter. But while growth will remain sluggish in the second half, an outright downturn seems unlikely.
Real gross domestic product fell 1% in the second quarter-its first drop in four years-after first-quarter growth of only 0.9%. Earlier interest-rate hikes in defense of the Canadian dollar, totaling 21/2 points, slammed housing and consumer durables. Slower U.S. growth hurt exports, especially of autos.
The good news is that the drags from higher rates and weaker exports are lifting. The Bank of Canada (BOC) trimmed its overnight lending rate on Aug. 28 by a quarter point, to a range of 6% to 61/2%, bringing total cuts since May to 13/4 points. Also, the U.S. economy is picking up after its first-half slowdown.
However, paring of excess inventories, plus budget cutting, both federally and in the provinces, most notably Ontario, will keep growth subdued. Finance Minister Paul Martin on Sept. 1 pledged to cut the federal deficit to 3% of GDP by 1997, "come hell or high water," even if the economy is weak.
Fiscal optimism and less concern over Quebec's separatist movement have strengthened Canada's dollar by 5.5% vs. the greenback since January. Quebec is the outlook's wild card. Its government is proceeding with plans to hold a "sovereignty" referendum this fall. Recent polls suggest that it might fail, but any pickup in support would spook the financial markets.
As long as a "no" vote seems likely, a good inflation outlook also gives the BOC room to cut rates. Consumer prices were flat in June and July, as annual inflation dipped to 2.5%. Weak consumer demand, amid stagnant labor markets where joblessness is near 10%, is forcing retail discounting, and wage pressures are nil.
Given these market supports, investors are snapping up high-yielding Canadian bonds. The spread on 10-year Canadian and U.S. government bonds favors Canada by about 11/2 points. And a failure of the sovereignty vote would be a big shot in the arm.BY JAMES C. COOPER & KATHLEEN MADIGAN