(Bloomberg) -- It’s a curious time to call for an export pick-up.
But that’s exactly what the Bank of Canada sees in store for the Canadian economy after hiking its policy rate to 1.5 percent on Wednesday. The central bank is expecting robust demand from the U.S. to trump the intensifying drag on trade from tariffs the two neighbors have imposed on each other, as well as the uncertainty over whether their long-standing free trade pact will be dissolved.
In its July Monetary Policy Report, policy makers estimated exports will contribute 0.5 percentage points to growth this year, up from zero in its April forecast. That’s despite American tariffs on steel and aluminum that shave 0.6 percent from total export volumes in 2018. The upgrade comes concurrently with a more bullish view on the country’s biggest trading partner. The bank raised its forecast for U.S. growth to 3.1 percent from 2.7 percent.
“The combined combination to growth of exports and investment will continue to be better than in recent years, even after incorporating the restraining effects of the U.S. tariffs and the Canadian countermeasures,’’ the bank said.
It’s a risky assumption. If the forecasts don’t pan out because of an escalation in trade tensions, that raises the prospect of another “serial disappointment” for the Bank of Canada. The central bank has long called for a rebalancing of growth toward external demand that has remained elusive.
Non-energy goods export volumes are up less than 5 percent since the middle of 2014, when oil and the Canadian dollar began to tumble. U.S. real imports have risen by 14.5 percent over this stretch. Non-commodity export volume growth, which turned negative in 2017, is forecast to turn positive this year and accelerate in 2019.
The outlook for cross-border commerce meanwhile is dimming quickly. A nascent trade war between the world’s two largest economies escalated on Tuesday evening, with the U.S. publishing a 200-page long list of Chinese goods that may be subject to tariffs. China said it was “shocked” by the U.S. threat and would take countermeasures in response.
It’s not just about exports. Business investment -- also disappointing since the Great Recession -- goes hand-in-hand with export growth at this point in the business cycle. Governor Stephen Poloz suggested the dampening effect that uncertainty is having on capital spending is impeding a more material pick-up in shipments abroad since exporters are facing capacity constraints.
“That hesitation to invest does two things: it slows down investment, obviously, but also slows down exports compared to what they normally would do,’’ he said June 27.
The better-than-anticipated export performance so far in 2018 has been mainly due to a rebound in oil shipments that came ahead of schedule, according to Wednesday’s report. Policy makers expect strength from other segments going forward, while cautioning that a lack of competitiveness will weigh on overall export growth.
“Buoyed by strong foreign demand, sectors that are planning to increase capital expenditures to expand capacity or innovate, such as machinery manufacturing and services, are expected to boost their exports,’’ the bank said.
Of particular importance to the Canadian economy will be whether the North America Free Trade Agreement stays intact. Despite fears that the highly interconnected North American auto sector could be the next target for levies by U.S. President Donald Trump, Poloz has insisted that the central bank will only incorporate changes to trade that have been announced and enacted into its decision-making process.
However, the Bank did elevate its concern regarding how a disruption to the Canadian auto sector would damage its outlook for the economy.
Border thickening in this industry would have “large impacts on investment and employment,” officials warned, which could have “negative spillovers on household spending and business investment in other sectors of the economy.”
©2018 Bloomberg L.P.