BUSINESS

A CURRENCY FREE-FALL

PRESSURE ON THE CANADIAN DOLLAR FORCES INTEREST RATES UP AND STALLS ECONOMIC RECOVERY

BRENDA DALGLISH November 30 1992
BUSINESS

A CURRENCY FREE-FALL

PRESSURE ON THE CANADIAN DOLLAR FORCES INTEREST RATES UP AND STALLS ECONOMIC RECOVERY

BRENDA DALGLISH November 30 1992

A CURRENCY FREE-FALL

PRESSURE ON THE CANADIAN DOLLAR FORCES INTEREST RATES UP AND STALLS ECONOMIC RECOVERY

BUSINESS

Soaring interest rates are rarely a reason for hope. But in Hope, B.C., last week, realtor Lynn Leach said that she was expecting the sudden rise in rates to turn into quick sales for her. In fact, Leach was planning to spend her weekend at the office because she anticipated a rush of buyers eager to take advantage of pre-approved mortgages at lower rates. She says that the latest rate increase will probably have the same effect on business as the sudden prereferendum increase in September. At that time, the ReMax office in the community, nestled at the foot of mountains on the edge of the Fraser River, was “insanely” busy. “Imagine a real estate office looking like a doctor’s waiting room,” said Leach. “People were lined up around here. Anyone who was thinking about buying jumped in and picked out a house.” She added that local banks were so swamped with mortgage applications that it took two weeks, instead of two or three days, to process them. And within days, Leach's office had sold its entire inventory of lowto mid-range properties. Despite the short-term windfall for realtors, however, savers are the only people who will truly benefit from the latest surge in interest rates.

Even the real estate buying spree will end quickly as the cost of higher interest seeps through the system. “It cannot be positive for

anybody,” said Tim O’Neill, president of the Atlantic Provinces Economic Council in Halifax. “The recovery will go on hold for as long as interest rates stay high.” Economists say that the Bank of Canada was forced to raise rates to prevent the Canadian dollar from falling too far, too fast. Despite the big rate hike, however, the dollar continued to fall, dropping 0.71 of a cent on Friday alone, and ending the week at 77.91 cents (U.S.). The dollar’s ongoing slide increases the likelihood that interest rates will have to rise even more. The dollar has been pushed down by a long list of negative factors. That list ranges from concerns about the federal government’s deficit increasing by perhaps as much as $7 billion more than the initial

forecast—to optimism about president-elect Bill Clinton, which is attracting international investors to U.S. markets.

To stabilize the dollar, the Bank of Canada increased domestic prime rates by 1.5 percentage points last week to 9 per cent from 7.5 per cent. As a result, some economists are now beginning to revise their economic growth forecasts for 1993 downward. Said Patti Croft, an economist at the investment firm of Bums Fry Ltd. in Toronto: “If it weren’t for the dollar’s problems, it would be absolutely ludicrous for rates to rise at a time when the economy is so weak and consumer confidence is shaken.”

In Ottawa, where the House of Commons

was back in session for the first time since Sept. 17, opposition MPs took Prime Mininster Brian Mulroney and Finance Minister Donald Mazankowski to task because of the country’s depressed economic condition. Mazankowski, who confirmed that the deficit for the 19911992 fiscal year will be $34.6 billion—$4.2 billion higher than he forecast in February and $7 billion higher than his forecast for the current year—said that he is preparing an economic statement for Dec. 2. And speaking to a group of Tory supporters at a party fund raiser in Ottawa last week, Mulroney reiterated his government’s five-part economic strategy. He also insisted that Ottawa’s priority of reducing the deficit would not change. "I can tell you that there will be no increase in taxes and no lessening of our resolve to reduce the deficit as a result of any one of these initiatives,” he said.

Many critics, however, said that Mulroney’s words rang hollow compared with the rhetoric that surrounded the presentation of the last federal budget, in February. At that time, Mazankowski hung his hopes for a recovery on an improvement in the U.S. economy and an upturn in domestic consumer confidence. “Our economy is poised for a sustained recovery on its own fundamental merits,” he said in his budget speech, “a recovery that draws on the strength of a dramatic improvement in interest rates, inflation and production costs.”

Although interest rates did fall from March into September, that decline ended in pre-

referendum jitters and rates are now higher than they were at the beginning of the year. So far, controlling inflation is one of the government’s few economic successes. In October, the consumer price index was running at a modest annual rate of 1.6 per cent, up slightly from September’s rate of 1.3 per cent, because of an average 8.4-per-cent increase in property taxes across the country. But the benefits of low inflation have clearly not revived the economy as quickly as Mazankowski had predicted.

The economic pressures facing the Conservative government, expected to call an election in the spring, are underscored by President George Bush’s defeat in an election campaign dominated by economic issues. However, Mulroney’s Conservatives appear to have few new proposals for reviving the economy. The Prime Minister’s economic strategy relies almost exclusively on previously announced plans, including the ratification of a North American Free Trade Agreement, the conclusion of a new General Agreement on Tariffs aud Trade and a reduction in government bureaucracy. It also includes a $300-million increase in jobtraining programs for the unemployed and investment in transportation systems and communications. In addition, Treasury Board president Gilles Loiselle announced that the government plans to cut its operating budget by $470 million, or two per cent, before March 31. More than a third of the cuts will come from the defence department, with additional cuts

from the RCMP and the prison system.

Although the transportation item on the economic shopping list is a relatively recent addition, Mulroney has not elaborated on how he will implement it. So far, he insists that the federal government will not borrow its half of the $ 14-billion cost of the program for road and infrastructure rebuilding. But the program has been stalled because Ontario is arguing that its contributions to the federal coffers warrant a larger share of the budget than Ottawa has proposed. As well, any massive new borrowing that the federal government does undertake would probably put even more upward pressure on interest rates. In turn, higher interest

rates will tug the economy backwards towards an ever-deepening recession.

Currently, the prime rate is almost three percentage points higher than it was two months ago, before the Canadian dollar took a nosedive in the anxiety-ridden weeks preceding the constitutional referendum. Banks have been slow to raise their prime in recent weeks because higher rates increase their customers’ costs and hence, the possibility that they will default on their bank loans. At the same time, the central bank’s policy of raising rates to attract new short-term dollar investments is often just a short-term solution. The so-called hot money (speculative short-term currency investments) that high rates draw leave whenever the opportunity for higher rates or lower risk investments arises elsewhere. But last week, the Bank of Canada was forced to do it twice—on Monday and again on Thursday—to keep up with the rise in interest rates required to buoy the falling dollar. Mortgage rates quickly followed: a one-year closed mortgage climbed by one percentage point to 8.5 per cent, while a five-year mortgage rose by one-

quarter of a point to 9.25 per cent.

With profits already squeezed at many banks this year because of the need to set aside massive reserves against their loans to the depressed commercial real estate sector, the banks were forced to move quickly last week to pass higher rates along to their customers. Through those increases, they ensured that the rate at which they lend money did not fall below the rates at which they borrow it. But, said Lloyd Atkinson, chief economist at the Bank of Montreal: “Higher interest rates are the last thing this economy—and our customers—need right now.”

Meanwhile, the dollar’s wobbly performance

was worsened by a combination of negative influences. They include:

• Growing government deficits, the need to borrow more to finance them and the possibility that, as a consequence, some federal and provincial governments may have their credit ratings downgraded again.

• Political uncertainties about upcoming elections, both nationally and in Quebec.

• Weak commodity prices, which affect the profitability of Canada’s resource-based economy.

• Problems at some key corporate enterprises including the Reichmann family’s Olympia & York Developments Ltd. and the Bronfmans’ Edper group.

• A weaker economic outlook than for the United States.

According to Toronto economist Croft, the attention focused on Canada during the referendum debate hurt the country by highlighting its battered economic state. “The referendum gave people a reason to look carefully at Canada,” she said. “On reflection, they didn’t like what they saw.” At the same time, the election

of Clinton, and the economic policy changes that his administration is expected to bring, have triggered considerable international optimism. Clinton’s victory, combined with hopeful economic signs in the United States, is causing foreign investors to opt for the United States over Canada.

Economists are divided over their expectations for the future, although most say that if the currency does not stabilize soon, allowing interest rates to come down, the higher rates will impede growth. “It depends how long they stay high,” said Atkinson. “In another month or two, if they are still up, I’m going to be marking down my forecasts.” He noted that the economy is so weak that there is no reason why interest rates need to stay high.

Some other economists say that the decline in the dollar, which will help exporters, provides enough extra economic stimulus to compensate for the rise in rates. The dollar has fallen by seven cents since January, and two cents since the beginning of November. The jump in rates had slowed the dollar’s descent, but observers say that it is still vulnerable. “The lower dollar is a boost to the economy,” said Mark Chandler, assistant chief economist with the Royal Bank of Canada. Chandler says that a twoor threecent decline in the value of the dollar is equal to a one-percentage-point fall in interest rates. “And one of the reasons the Canadian dollar is weak is because the U.S. dollar is strong,” he added. “That’s good for us because it

0 means the U.S. economy is

1 recovering.”

Most experts say that if the currency stabilizes near its current level, the Bank of Canada will again start to ratchet down interest rates. Said Atkinson: “There is no fundamental economic reason why interest rates are this high.” But others say that the new pessimism about Canada will prevent rates from falling back to their September lows. Said Chandler: “I do not think you will see them as low as they were before the referendum.”

That is bad news for an economy that was just beginning to show signs of life. Pearse Murray, a real estate agent with Family Trust Corp. in downtown Toronto, says that the past three or four months—when interest rates fell to their lowest level in 20 years—were his busiest in three years. But the jump in rates will end that. “People are so scared in so many ways, about their jobs, about the government,” he said. “Higher mortgage rates are just one more thing to frighten them.” He says that he has several buyers who are actively looking for homes. But, unlike his fellow realtor, Lynn Leach, in Hope, Murray is not counting on a buying rush, either this week—or anytime in the foreseeable future.

BRENDA DALGLISH

GLEN ALLEN