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Developments that could affect Canada’s economy

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VANCOUVER — For Canada, what happens beyond our borders is often more important to our economic prospects than what transpires at home. With that in mind, here are three things that Canadian forecasters and market analysts will be carefully tracking in 2014.

U.S. monetary policy: the end of quantitative easing

Since the start of the 2008-09 recession, the U.S. Federal Reserve has taken unprecedented steps to support the American economy and provide liquidity to a malfunctioning financial system. Not only has the U.S. central bank kept its short-term policy interest rate pinned near zero for five years, it has also engaged in massive purchases of financial assets, notably government bonds and mortgage-backed securities, which has served to push up bond prices, lower bond yields and put downward pressure on interest rates generally — a strategy known as "quantitative easing" (QE). As a result, the Federal Reserve’s balance sheet quadruped in size between 2007 and 2013.

In recent months, U.S. policymakers have been moving to dial back QE by reducing the scale of asset purchases; this process of "tapering" is expected to continue over 2014. A year from now, QE may have ended, setting the stage for a further normalization of U.S. monetary conditions in 2015 when the Federal Reserve is likely to begin raising its short-term policy interest rate.

How will this shift in monetary policy affect the global economy? Already, the anticipation of higher American interest rates together with stronger U.S. growth has triggered a sharp drop in equity markets in many emerging economies as well as a sell-off of their currencies. The Canadian dollar has also lost ground, as investors judge that interest rates will climb faster in the U.S. than here. The winding down of QE means that financial and currency markets may be unusually volatile this year — creating an added source of uncertainty to the economic outlook.

Europe returns to growth

After eight consecutive quarters that saw either outright declines in GDP or essentially zero growth, the Eurozone — the 18 European countries that share a single currency and central bank — finally emerged from recession in the third quarter of last year. While far from fully resolved, the sovereign debt crisis that has dogged the region since 2011 has eased, with borrowing costs falling for the most financially-distressed countries (Greece, Spain, Portugal, Italy and Ireland). Some progress is being made in forging a proper "banking union" for the Eurozone, the European Central Bank is providing a credible backstop for the member countries’ bond markets, and the U.K. economy — which is not part of the Eurozone — is also rebounding. Fiscal austerity, poorly functioning banking systems, and high unemployment continue to weigh on economic activity across much of the region, and inflation is hovering at an alarmingly low level — all of which suggests that any acceleration in economic growth will be muted in the near-term. But at least Europe is no longer subtracting from global economic expansion.

Japan struggles to revive its economic engine

A third external story that matters to Canada is unfolding in Japan, the world’s third largest national economy. There, the government led by Prime Minister Shinzo Abe is engaged in a multi-pronged effort to reinvigorate the economy. Japan’s central bank has commenced a massive and full-throated campaign of monetary stimulus designed to break an entrenched pattern of falling prices, in the hope of reversing the economic stagnation which has long been fed by deflationary pressures. The government is also rolling out a significant reform agenda to open up Japan’s long-cossetted agricultural and services markets, boost new business formation, and draw more women into the country’s aging workforce. Although Japan faces daunting long-term demographic and public finance challenges, the International Monetary Fund sees its GDP increasing by 1.7 per cent in 2014, similar to last year. The government’s reform agenda could stall or even fail, but for now brisker growth in Japan is helping the global economy.

Canadian policymakers, investors and business decision-makers will need to keep a close eye on developments in these key advanced country economies in the year ahead.


Jock Finlayson is executive vice president of the Business Council of British Columbia.



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