BUSINESS

PRIMING FOR A RECOVERY

DESPITE A LARGE DROP IN INTEREST RATES, THERE ARE ONLY A FEW SIGNS OF AN ECONOMIC TURNAROUND

JOHN DALY May 20 1991
BUSINESS

PRIMING FOR A RECOVERY

DESPITE A LARGE DROP IN INTEREST RATES, THERE ARE ONLY A FEW SIGNS OF AN ECONOMIC TURNAROUND

JOHN DALY May 20 1991

PRIMING FOR A RECOVERY

BUSINESS

DESPITE A LARGE DROP IN INTEREST RATES, THERE ARE ONLY A FEW SIGNS OF AN ECONOMIC TURNAROUND

Regina car dealer Lorne Pfeffer says that he is puzzled why declining loan rates have yet to trigger a rush of buyers into his Volkswagen showroom. In recent weeks, Canada’s chartered banks have reduced their new-car loan rates to as low as 12 per cent as part of a general cut in interest rates. The best rates are now about five percentage points lower than their peak last summer. But the business manager says that sales at Regina Volkswagen (1988) Ltd. last month were only about five per cent higher than the depressed levels of a year ago— roughly the same as the average increase experienced by all Canadian auto dealers over the same period. He also says that he doubts whether further interest-rate declines alone will ignite car sales and help to raise Canada’s economy out of the current recession. “They would have to decline a lot more to make a difference,” he says. “People are still holding on to their money.”

Still, there were some signs last week that the lower rates were having a positive economic impact. For the first time since June, 1990, Statistics Canada reported that the monthly unemployment rate showed an improvement, decreasing to 10.2 per cent in April from 10.5 per cent in the previous month. In addition, the number of housing starts in April was 33 per cent higher than in March. However, while economists welcomed the trend in those two important indicators, they warned that it is insufficient to indicate a recovery. There are still about 400,000 more people out of work now than a year ago, and housing starts remain well below the levels of a healthy economy. In an apparent effort to stimulate business and consumer spending, the Bank of Canada last week lowered its trendsetting interest rate to 9.22 per cent, from 9.33 per cent the previous week. At week’s end, however, none of Canada’s six largest banks responded to the central bank’s action by lowering their lending rates.

Many economists say that the fact that 1.4 million Canadians are unemployed shows that the country remains mired in a recession, and that the continuing weakness in the economy will force lenders to lower interest rates even further. The Bank of Montreal’s chief economist,

Lloyd Atkinson, for one, says that “there is no compelling evidence at this point that the recession is over.” He predicts that interest rates for most types of loans will decline by at least another percentage point from their current levels. He adds that the 9.75-per-cent rate that his bank now offers prime customers, the lowest rate by one-half of a point among the six major banks, could fall by another half a percentage point this year.

Atkinson says that the current downturn in Central Canada’s manufacturing sector is the most severe since the 1981-1982 recession, and that when a recovery begins later this year, it likely will be slow. As a result, he says, rates will stay relatively low for some time. TorontoDominion Bank chief economist Douglas Peters agrees that further declines are likely. Declares Peters: “I would hope that we can have more than a percentage-point reduction in the prime rate.”

But other economists take a rosier view of the economy. They say that last week’s improvement in unemployment and housing starts, combined with recent upswings in car sales and sales of existing houses, is a sign that a general turnaround is imminent. Led by a strong surge in the near-dormant Toronto real estate market, countrywide sales of existing houses jumped to 33,883 units in March, up 9.3 per cent from the same month a year ago. Edward Neufeld, chief economist at the Royal Bank of Canada, says that “as far as interest rates go, I think we’re getting close to the bottom.” And he predicts that a general economic recovery beginning this summer will put upward pressure on interest rates.

Neufeld and many other economists argue that further reductions in rates are unlikely because Bank of Canada governor John Crow remains determined to lower inflation, now running at an annual rate of 6.3 per cent, to the 1995 target of two per cent set out in the February federal budget. Still, last week’s bank-rate reduction suggested that Crow is willing to moderate his anti-inflation crusade— at least temporarily—in. order to prevent the recession from deepening even further. But if the Canadian dollar begins to fall on international currency markets, Crow will likely resist any further declines in the bank rate. That is because a lower dollar, while good for exporters, would drive up the inflation rate by making imported goods more expensive. It would also make it more difficult to attract foreign investment.

SOURCES BANK OF CANADA, BANK OF MONTREAL

Peters, however, says that Crow has room to lower interest rates further. Despite the steady decline in Canadian rates since last fall, he says that the 3.5-percentage-point spread between Canadian and U.S. rates is still unusually high by historical standards. Peters adds that he is concerned that Crow’s tight money policy could prevent an economic resurgence, tipping Canada back into recession in 1993.

Many hard-pressed Canadian businessmen, including home builders and construction suppliers who are only now beginning to feel the benefits of lower rates after a punishing 18-month slump, also say that rate increases could choke off a recovery. Doug Williams, president of Toronto-based McKnight Window Industries Ltd., says that he laid off two-thirds of the 100 assembly workers at his plant last year as orders from builders dried up. Now, he says that he is planning to increase his payroll to fill a recent flurry of new orders. “The lower interest rates are a step in the right direction,” he adds. “But it’s still a long road back.”

The federal treasury also stands to benefit if interest rates continue to decline. Current market rates are roughly in line with those forecast in the Mulroney government’s February budget. But according to finance department estimates, Ottawa’s projected $30.5-billion deficit for the current fiscal year would shrink by $1.8 billion if rates average a percentage point lower than the 9.5-per-cent level predicted for 1991. Still, the Bank of Montreal’s Atkinson cautions that if rates continue to decline because of the economy’s weakness, much of those savings would disappear. He says that the money Ottawa saves in interest payments would be offset by lower tax revenues and higher social welfare costs.

Atkinson and his counterparts at the other banks decline to advise consumers on whether they should take advantage of the current low interest rates and buy a house or a car now, or wait for further declines. Peters, for one, says that consumers should be wary of trying to predict the absolute bottom of the market. “Bulls and bears sometimes profit,” he says. “But pigs always end up in the dirt.”

Even if interest rates continue to decline, however, most economists say that the prospect of a sharp increase in personal borrowing similar to the one that helped lift Canada out of the 1981-1982 recession is highly unlikely. They predict that increases in unemployment will continue to dampen consumer confidence and reduce disposable income this year. As well, the record-high level of consumer debt— now $13,600 for every man, woman and child in the country—will almost certainly inhibit new borrowing. That means that model homes and auto showrooms probably will experience light traffic for many months to come.

JOHN DALY