Queen’s School of Business Hosts 25th Annual Business Forecast Lunch

December 13, 2006 – Queen’s School of Business professors made their economic predictions for 2007 at the 25th annual Business Forecast Lunch today in Kingston, Ontario. An expert panel of faculty presented the economy’s prospects with a focus on their own particular expertise, including a review of the 2006 forecast.

Economics Professor John McHale took the macroeconomic perspective, touching on issues such as inflation and unemployment. Lew Johnson, Professor of Finance, focused on the financial markets, while Strategy and Entrepreneurship Professor Elspeth Murray took a look at factors affecting industry and technology. And finally, Marketing Professor Ken Wong discussed the local economy, analyzing Kingston’s economic development prospects. A summary of the panel’s forecast is included below.

The Business Forecast Lunch was founded 25 years ago by Queen’s School of Business professor emeritus Merv Daub to establish an important link between the School and the Kingston business community. The 2006 event, hosted by Dean David Saunders, attracted record attendance.

Macroeconomic Outlook

The national economy has been losing momentum over the course 2006. The growth rate was just 1.4 percent (annualized) in the third quarter, down from 3.8 percent in the first quarter and 2.0 percent in the second. The panel forecasts relatively tepid growth for the upcoming year as well, with real GDP increasing by 2.4 percent.

On the inflation front, the current low rate (0.9 percent in October) will not be sustained. This low rate reflects the unwinding of the energy price spikes that followed Hurricane Katrina in the fall of 2006. The core inflation rate—which excludes the most volatile components of the CPI—was 2.3 percent in October The panel forecasts that the inflation rate will be two percent over the coming year.

The national unemployment rate has been on a declining trend over the last few years and stood at 6.3 percent in November. However, this trend hides considerable variation across the provinces. Over the last year, the unemployment rate fell by 1.1 percentage points in Alberta (reaching 3.1 percent in November), while it rose by 0.3 percent in Ontario (reaching 6.4 percent in November). The panel forecasts that the national unemployment rate will rise slightly to 6.4 percent over the coming year.

The Bank of Canada substantially hiked interest rates over the first half of the year, but has been in a holding pattern since May. The current target for the overnight rate is 4.25 percent and the Business prime rate is 6 percent. The panel forecasts a modest decline in both rates of a quarter of a percentage point over the next twelve months.

The exchange rate fluctuated in a narrow band over the course of 2006. The panel expects this pattern to continue and forecasts a rate of U.S. $0.87 per Canadian dollar for December 2007. The main upside risk to this forecast comes from the possibility foreign investors will accelerate their unloading of U.S.-dollar assets. This trend is already being observed for some Middle Eastern central banks.

On the policy front, the panel is impressed by the macroeconomic management of the monetary and fiscal authorities. Going forward, we have confidence that the Bank of Canada will keep inflation close to the two percent target and output growth close to the economy’s underlying potential growth rate. The potential growth rate is currently estimated to 2.8 percent. This is the growth rate that is consistent with stable inflation. We also expect the federal government to maintain the hard-won budget surplus.

However, this sound management of the business cycle is taking place against an increasingly disappointing performance on the productivity front. This is of concern because productivity growth is what drives improvements in living standards over the longer run. The productivity gap between the U.S. and Canada is large and growing, which suggests Canada is falling short of its potential. Adding to the concern, measured productivity growth was negative over the last two quarters. There needs to be a national debate about how to improve national productivity performance.

Financial Markets Outlook

Expect short term interest rates to decline by about 25 basis points (0.25%) during 2007, while long term rates should remain about the same. After a good year in 2006, stock markets should be more stable next year, with investors encouraged to shift to value stocks rather than growth stocks. Energy prices should not increase substantially but there could be periodic volatility due to world events. Expect a slowdown in the U.S. in the run-up to the expected Democratic victory in 2008. The worsening U.S. trade deficit could impact on the U.S. dollar, while the Canadian dollar should be relatively stable. Watch for pre-election goodies from both major parties, especially in the form of tax relief. The Liberals might even surprise us with revisions to the proposed taxation of income trusts, possibly adopting the Bloc recommendation of a ten-year transition period.

Industry/Technology

In 2007, executives will have numerous issues to keep them awake at night — some old, some new. In the old category, the aging population continues to wreak havoc within the workplace with a new twist forming based on the age-old 'generation gap'. In the new category, the unrelenting 'progress' of technology is creating huge opportunities as well as huge headaches, as several critical technologies get better, faster and cheaper. Also new: globalization is taking on new dimensions with some very interesting and positive aspects for North America and Canada as post-911 security issues appear to overshadow overseas cost advantages. Individually, the implications of these trends are intriguing. In combination, however, the dreams and nightmares are endless.

Local Economy Outlook

The local economy is a very tough call this year. On the surface, and in comparison to recent years, Kingston is doing reasonably well. We continue to create jobs, our unemployment is falling and more of our jobs are full-time. Consumer bankruptcies are down and while business bankruptcies are up, the rate of increase is lower than past years. In addition, we are coming off a year of astronomical increase in housing starts (up over 100%) and incomes and retail sales were up a healthy 6.5% versus provincial averages of less than 5% for each. Indeed, if one were to consider these statistics alone we might well conclude that our economic engine is healthy and that we can ease the pressure on the accelerator somewhat.

But before we go too far in celebration, it is insightful to compare Kingston’s seeming prosperity with what has been happening elsewhere. Because on almost every measure and by almost every external study, Kingston is NOT one of the strongest local economies and, at least on one key indicator, non-residential building permits, it comes dead last among Canada’s 40 largest CMAs.

Thus, 2007 will be another mixed year. On the surface, a reasonable year with the exception of housing starts. But Kingston will lose ground relative to other CMAs both within Ontario and across Canada. Indeed, were it not for an onslaught of planned public spending programs, the forecast for Kingston might well be abysmal because the persistent problems of low population growth, an aging population, extremely high levels of employment variability and a tax base that remains over three-quarters residential.

This will create a major dilemma for City Council as it strives to set priorities between social programs and economic development. Recent elections showed a distinct voter preference for social spending and infrastructure programs across Ontario (i.e. not just Kingston) and there is no reason to believe Kingston’s new council will be much different from other CMAs. At the same time, the long sales cycle of economic development efforts suggests that any premature withdrawal of economic development activity could prove fatal to the City’s long-range prospects.

For a copy of the Business Forecast Lunch presentation, please click here.