2010 Ontario Economic Outlook and Fiscal Review

CHAPTER 2: Ontario's Economic Outlook

HIGHLIGHTS

  • Government-projected 2010 real gross domestic product (GDP) growth — 3.2 per cent.
  • Average private-sector projected 2011 real GDP growth — 2.4 per cent.
  • Government-projected 2011 real GDP growth — 2.2 per cent, for prudence.
  • Percentage of Ontario real GDP recovered since the recession, as of the second quarter of 2010 — 71 per cent.
  • Percentage of Ontario jobs lost during the recession recovered as of October 2010 — 75 per cent.

OVERVIEW

While the economy is emerging from the global recession, Ontario's families and businesses are still feeling the effects of the financial and economic crisis. Key economic indicators have improved from lows during the recession, but most remain below pre-recession levels. As of the second quarter of 2010, Ontario had recovered 71 per cent of the loss in real GDP. Employment has grown solidly since the recession ended, regaining 75 per cent of the jobs lost in the downturn. Key indicators of trade and manufacturing, on the other hand, remain well below pre-recession levels, reflecting continuing soft demand in the United States, Ontario's main market.

Chart 1: The Progress of Ontario's Economic Recovery

The Ministry of Finance is assuming real GDP growth of 3.2 per cent in 2010, 2.2 per cent in 2011, 2.5 per cent in 2012 and 2.7 per cent in 2013. This is 0.2 of a percentage point below the private-sector average each year to be prudent.1

Table 1
Ontario Economic Outlook
  2007 2008 2009 2010p 2011p 2012p 2013p
Real GDP Growth 2.0 (0.9) (3.6) 3.2 2.2 2.5 2.7
Nominal GDP Growth 4.2 0.1 (1.1) 5.6 4.1 4.5 4.6
Employment Growth 1.6 1.4 (2.4) 1.7 1.7 1.8 1.9
CPI Inflation 1.8 2.3 0.4 2.3 2.1 2.0 2.0
  • p = Ministry of Finance planning projection.
  • Sources: Statistics Canada and Ontario Ministry of Finance.

Economic forecasts for 2010 have improved compared to those in the 2010 Ontario Budget, but have weakened for subsequent years, largely caused by weaker anticipated U.S. growth. As well, there are significant risks to the outlook, particularly the ongoing challenges in the global economy. Key risks include sovereign debt concerns, trade imbalances and uncertainty regarding the U.S. economic recovery.

Chart 2: The Progress of Ontario's Economic Recovery
THE STATE OF ONTARIO'S ECONOMIC RECOVERY

There are clear signs that a recovery is taking shape in Ontario. Key indicators have improved from lows posted during the recession. After declining for four consecutive quarters — falling 4.9 per cent from the second quarter of 2008 to the second quarter of 2009 — Ontario real GDP has increased for four consecutive quarters, rising 3.7 per cent or $18.6 billion. Despite the improvement, the level of real GDP in the second quarter of 2010 was 1.4 per cent below the pre-recession level.

The pace of growth slowed to 0.6 per cent in the second quarter, down from 1.4 per cent in the first quarter and 1.5 per cent in the fourth quarter of 2009. Recent data for the third quarter reveal further signs of weakening economic growth. Employment growth slowed to 0.4 per cent (or 27,700 jobs) from 1.2 per cent (or 81,600 jobs) in the second quarter. Retail sales in July and August were down 0.1 per cent from the second quarter. Ontario's trade balance also deteriorated as merchandise imports rose 3.0 per cent from the second quarter, while exports declined 0.8 per cent.

Chart 3: Pace of Ontario Real GDP Growth is Slowing

Ontario's real GDP growth in 2010 is expected to be faster than in all other provinces except British Columbia and Newfoundland and Labrador and stronger than in both Canada and the United States as a whole.

Chart 4: Comparative Real GDP Growth Forcast: 2010

From September 2008 to May 2009, Ontario employment dropped by 249,700. Since May 2009, as the Ontario economy has strengthened, employment has increased by 2.9 per cent or 186,100 net new jobs. Despite the severity of the recession's impact on employment, 75 per cent of the jobs lost have been recovered. Since May 2009, Ontario's job growth has been stronger than that of most other provinces and significantly above that of the United States as a whole and most U.S. states.

Chart 5: Ontario Jobs Returning

Ontario's export sector, like that of all other Canadian provinces, suffered a sharp decline in activity during the global recession. Ontario's international merchandise exports have recovered almost one-half of the decline that occurred during the downturn, but remain 18.1 per cent below the pre-recession level. Ontario auto production has also improved, rising to 493,993 units in the third quarter of 2010, well above its recession low of 280,035 units and almost 20 per cent higher than a year earlier.

Chart 6: Exports* Continue to Gradually Recover

GLOBAL CHALLENGES AFFECT ONTARIO

Ontario's economic outlook is heavily influenced by global economic and financial conditions, particularly U.S. demand, oil prices, the Canadian dollar exchange rate and interest rates. Private-sector forecasts for these factors are summarized in the table below.

Table 2
External Variables
Average Private-Sector Forecast
  2010 2011 2012 2013
U.S. Real GDP Growth (Per Cent) 2.7 2.5 3.2 3.0
Crude Oil ($ US per Barrel) 77.9 82.6 86.6 92.6
Canadian Dollar (Cents US) 96.2 97.7 98.5 98.3
Three-Month Treasury Bill Rate* (Per Cent) 0.6 1.6 3.0 3.9
10-Year Government Bond Rate* (Per Cent) 3.2 3.2 4.1 4.8
  • *Government of Canada interest rates.
  • Sources: Blue Chip Economic Indicators (November 2010) and Ontario Ministry of Finance Survey of Forecasts.
U.S. ECONOMIC GROWTH UNCERTAIN

The United States is Ontario's most important export market, accounting for about 80 per cent of the province's international exports in 2009. Ontario has benefited from a rebound in U.S. economic activity, with exports up 16.8 per cent so far this year, in large part reflecting a recovery in U.S. auto sales. However, recent indicators generally point to a slowing in U.S. economic growth and the pace of expansion is expected to be modest going forward.

U.S. real GDP advanced 0.4 per cent in the second quarter of 2010 and 0.5 per cent in the third quarter of 2010, much slower than the pace in the previous two quarters. The slowdown in U.S. growth largely reflects moderating export growth. As well, home-buying activity declined sharply following the end of the U.S. Homebuyer Tax Credit program this spring.

Chart 7: U.S. Real GDP Growth

The U.S. economy is expected to grow by 2.7 per cent in 2010 and 2.5 per cent in 2011. As the recovery gains traction, U.S. real GDP is expected to increase by 3.2 per cent in 2012 and 3.0 per cent in 2013.

The outlook for U.S. growth has eased since the 2010 Budget, with real GDP growth lower by 0.4 of a percentage point in 2010 and 0.5 of a percentage point in 2011. Job creation in the United States has been slow, leading to weak income growth.  This, in addition to tighter credit standards and declining household credit growth, is contributing to weak consumer spending and a slower recovery in housing.

The auto industry is a key part of Ontario's economy and its performance is heavily reliant on U.S. demand. U.S. auto sales fell from a recent peak of 16.5 million units in 2006 to a low of 10.4 million units in 2009. Sales are expected to increase to 11.5 million units in 2010, 12.6 million units in 2011, 14.0 million units in 2012 and 14.7 million units in 2013. However, U.S. demand for Ontario exports will continue to be hampered by weak household income and credit growth, the high value of the Canadian dollar and the unwinding of U.S. government actions to stimulate the economy. In addition, the problems plaguing the U.S. housing market appear to be far from over.

Chart 8: U.S. Auto Sales
OIL PRICES TO EDGE UP

The cost of imported oil to the Ontario economy in 2009 was approximately $15 billion. There is a wide range of views on the future path of oil prices. Private-sector forecasters, on average, expect oil prices to average $78 US per barrel in 2010 and then steadily rise to $93 US per barrel in 2013 as the world economy strengthens. For planning purposes, the Ministry of Finance forecast is based on the futures contract for oil prices, which indicates a gradual increase in crude oil prices as the economic recovery continues.2

Chart 9: Crude Oil Prices
CANADIAN DOLLAR STRENGTHENING

The Canadian dollar has risen sharply from its recent low of 77 cents US in March 2009, influenced by a rebound in commodity prices, a broader depreciation in the U.S. dollar against most currencies, and Canada's favourable economic and fiscal position among developed nations. Private-sector forecasters expect the exchange rate to increase modestly, with the annual average approaching parity with the U.S. dollar. A rise in the exchange rate makes it more challenging for Ontario's exporters to compete internationally and for domestic firms to compete with foreign producers. However, a higher dollar benefits businesses by lowering the cost of importing productivity-enhancing machinery and equipment.

Chart 10: Crude Oil Prices

INTEREST RATES

Interest rates for both businesses and consumers remain near record lows. The Bank of Canada increased its overnight policy interest rate to one per cent, from close to zero earlier this year, but is now expected to pause until 2011 before further increasing interest rates. In the medium term, the Bank of Canada is expected to continue raising interest rates to more normal levels. Interest rates affect consumer spending and business investment as well as the projected expense for interest on the Province's debt. For more information, see Chapter 4: Borrowing and Debt Management.

Chart 11: Interest Rates
GLOBAL FINANCIAL RISKS

Global financial conditions remain unsettled. Earlier this year, financial market investors became increasingly concerned about the sustainability of sovereign debt in a number of European countries. This raised borrowing costs for those economies and resulted in global financial market volatility. Although the volatility has eased in recent months as those countries have announced measures to reduce budget deficits and have received financial support from the European Union, considerable uncertainty remains about the sustainability of their debt financing.

In Canada, the global financial crisis had considerably less impact than in other countries, leaving borrowing costs relatively low and credit growth solid. At the same time, the recovery in world commodity prices, together with Canada's sound economic fundamentals, has increased the attractiveness of Canadian financial assets among international investors, keeping bond rates low and supporting a rising Canadian dollar. The risk premium that banks require to lend to each other, rather than to hold risk-free Government of Canada treasury bills, has returned close to historically normal levels.

Chart 12: Credit Risk Has Diminished in Canada

The Bank of Canada's Senior Loan Officer Survey, released in October 2010, reported continued improvement in business credit conditions for the fourth consecutive quarter. Household credit growth has been slowing but remains positive, supported by low borrowing costs. However, the rise in household debt relative to personal income means that some households could face increasing challenges meeting their debt obligations in the future, as interest rates move higher. Also, as household interest expenses rise, less money will be available for spending on goods and services.

IMPACT OF CHANGES IN GLOBAL FACTORS

Table 3 shows the implications of changes in the key external factors for Ontario's growth. The wide range shows the uncertainty and risks surrounding the Ontario economic outlook

Table 3
How Sustained Changes in Key Assumptions Would Affect Ontario Real GDP Growth
(Percentage Point Decrease)
  First Year Second Year
Canadian Dollar Appreciates by Five Cents US 0.1 to 0.8 0.5 to 1.2
World Crude Oil Prices Increase by $10 US per Barrel 0.1 to 0.3 0.1 to 0.3
U.S. Real GDP Growth Decreases by One Percentage Point 0.3 to 0.7 0.4 to 0.8
Canadian Interest Rates Increase by One Percentage Point 0.1 to 0.5 0.2 to 0.6
  • Source: Ontario Ministry of Finance.

OUTLOOK FOR ONTARIO'S ECONOMIC RECOVERY

Sustained moderate growth is expected for the Ontario economy. This outlook is based on continued growth in Ontario export markets and increasing demand for consumer goods and services as well as housing. Increased tax competitiveness as a result of Ontario's Tax Plan for Jobs and Growth will encourage business investment and jobs.

Ontario's export growth is reviving as the U.S. and global economies recover. Ontario's trade with the rest of the world will benefit from increased demand for commodities, industrial goods, and machinery and equipment, particularly from emerging Asian markets. As well, economic growth in other provinces will support interprovincial exports. Real exports are forecast to increase by 10.6 per cent in 2010 and an average of 4.6 per cent annually over 2011 to 2013, reflecting the improving global economic environment.

Chart 13: Credit Risk Has Diminished in Canada

Following the large decline last year, improving business conditions are expected to support a strong rebound in corporate profits, which are projected to rise by an average of 8.7 per cent annually between 2010 and 2013. The rebound in corporate profits, along with rising global demand and increased tax competitiveness, will support stronger business investment over the coming years. Investment in machinery and equipment is expected to increase by an average of 8.4 per cent annually between 2010 and 2013, while investment in non-residential construction is projected to increase by an average of 4.7 per cent annually.

Chart 14: Credit Risk Has Diminished in Canada

Ontario's economic recovery continues to be supported by strong public-sector capital investments. Following strong growth in 2009 (14.0 per cent), capital expenditures by all levels of government in Ontario are expected to increase by a further 16.4 per cent in 2010, second among all provinces and well above the national average (9.9 per cent). For more information on Ontario government infrastructure investments, see Chapter 1: Open Ontario.

Chart 15: Recovery Supported by Strong Government Planned Investment for 2010

Ontario housing prices rebounded following the economic downturn, surpassing previous peaks. This was supported by low interest rates and strong underlying demand. Because Ontario did not experience the same housing boom that occurred in other jurisdictions prior to the global financial crisis, prices did not fall as far during the recession. Since the recessionary low, existing home prices have increased by 22 per cent in Ontario and currently stand at about 10 per cent above their pre-recession level. Housing prices in the United States have increased by eight per cent since the trough but remain 28 per cent below the peak, while prices in the United Kingdom have increased by 11 per cent and remain at 12 per cent below the peak.

Chart 16: Modest Rise in Ontario House Prices

Strong underlying demand and a fundamentally sound housing market will support healthy growth in both housing sales and prices over the medium term. Sales are expected to increase by an average of one per cent annually between 2010 and 2013 and prices are expected to rise by an average of close to two per cent annually, in line with overall inflation. An increase in the number of households will mean a rise in demand for new homes, supporting a gradual pickup in housing starts, which are projected to increase from 60,000 units in 2010 to 68,000 units by 2013.

Chart 17: Nearly Half a Million Jobs Expected

Employment is projected to increase by 1.7 per cent in 2010, up from the 1.1 per cent projected in the 2010 Budget. The unemployment rate is projected to average 8.8 per cent in 2010, down from 9.0 per cent in 2009, as job creation outpaces the increase in the number of people looking for work. Job gains are expected to average 1.8 per cent annually over 2011 to 2013, resulting in 480,000 more jobs in 2013 than in 2009. Ontario's employment forecast is in line with private-sector forecasts.

Solid job gains this year have contributed to stronger-than-expected spending growth. Retail sales for 2010 are now forecast to grow by 4.5 per cent, up from the 3.9 per cent forecast in the 2010 Ontario Budget. Similarly, real consumer spending is projected to increase by 2.8 per cent in 2010, up from 2.2 per cent in the 2010 Ontario Budget. Retail sales are projected to grow by an average of 4.1 per cent annually over 2011 to 2013, and overall real consumer spending growth is expected to average 2.4 per cent annually.

Ontario's Consumer Price Index (CPI) inflation rate is expected to average 2.3 per cent in 2010, following a 0.4 per cent increase in 2009. Private-sector economists expect Ontario's CPI inflation rate to be 2.1 per cent in 2011. In 2012 and 2013, it is projected to average 2.0 per cent annually, the mid-point of the Bank of Canada's target range of one to three per cent.

DETAILS OF THE ONTARIO ECONOMIC OUTLOOK

The following table shows details of the Ministry of Finance's economic outlook for 2010 to 2013.

Table 4
The Ontario Economy, 2008 to 2013
(Per Cent Change)
  Actual Projection
  2008 2009 2010 2011 2012 2013
Real Gross Domestic Product (0.9) (3.6) 3.2 2.2 2.5 2.7
Personal Consumption 2.7 0.1 2.8 2.4 2.5 2.4
Residential Construction (3.1) (8.1) 10.5 (2.5) 4.3 4.0
Non-residential Construction (2.5) (18.4) 2.6 5.1 5.8 5.3
Machinery and Equipment 0.3 (19.0) 8.0 11.8 7.4 6.4
Exports (6.2) (13.2) 10.6 5.0 4.5 4.2
Imports (2.1) (10.8) 13.2 5.2 4.0 3.9
Nominal Gross Domestic Product 0.1 (1.1) 5.6 4.1 4.5 4.6
Labour Market Indicators            
Employment 1.4 (2.4) 1.7 1.7 1.8 1.9
Job Creation (000s) 94 (161) 114 113 124 130
Unemployment Rate (Per Cent) 6.5 9.0 8.8 8.4 7.8 7.2
Other Economic Indicators            
Retail Sales 3.9 (2.5) 4.5 4.1 4.2 4.0
Housing Starts (000s) 75.1 50.4 60.0 57.0 62.0 68.0
Personal Income 2.7 (0.2) 3.4 4.1 4.5 4.7
Labour Income 2.9 (1.0) 4.0 4.2 4.7 4.8
Corporate Profits (10.9) (13.6) 17.0 4.9 7.5 6.0
Consumer Price Index 2.3 0.4 2.3 2.1 2.0 2.0
Key External Variables            
Crude Oil ($ US per Barrel) 99.6 61.8 79.2 87.9 89.8 90.2
U.S. Real Gross Domestic Product 0.0 (2.6) 2.7 2.5 3.2 3.0
Canadian Dollar (Cents US) 93.7 87.6 96.9 98.0 98.5 98.5
3-month Treasury Bill Rate* 2.3 0.3 0.6 1.6 3.0 3.9
10-year Government Bond Rate* 3.6 3.3 3.2 3.2 4.1 4.8
  • *Government of Canada interest rates (per cent).
  • Sources: Statistics Canada, Canada Mortgage and Housing Corporation, Bank of Canada, New York Mercantile Exchange, U.S. Bureau of Economic Analysis, Blue Chip Economic Indicators and Ontario Ministry of Finance.

PRIVATE-SECTOR FORECAST

The Ministry of Finance surveys private-sector forecasts to determine appropriate planning assumptions. Private-sector forecasters are calling, on average, for Ontario real GDP to grow by 3.4 per cent in 2010, 2.4 per cent in 2011, 2.7 per cent in 2012 and 2.9 per cent in 2013. The range of forecasts for 2011 is quite wide. RBC Financial Group is the most optimistic, calling for growth of 3.2 per cent, while CIBC World Markets is the most pessimistic, expecting growth of only 1.7 per cent.

Table 5:
Private-Sector Forecasts for Ontario Real GDP Growth
(Per Cent)
  2010 2011 2012 2013
BMO Capital Markets (November) 3.4 2.3
Centre for Spatial Economics (July) 3.7 2.9 2.5 2.4
CIBC World Markets (September) 3.4 1.7 2.6
Conference Board of Canada (October) 3.5 2.6 3.0 3.5
Desjardins Group (October & September) 3.4 2.5 2.0 2.5
IHS Global Insight (July) 3.5 3.0 3.1 2.8
RBC Financial Group (November) 3.5 3.2
Scotiabank Group (November) 3.5 2.0
TD Bank Financial Group (September) 3.2 1.9 2.6
University of Toronto (October) 3.2 1.8 3.1 3.2
Private-Sector Survey Average 3.4 2.4 2.7 2.9
Ontario's Planning Assumption 3.2 2.2 2.5 2.7
  • Sources: Ontario Ministry of Finance and Ontario Ministry of Finance Survey of Forecasts (November 8, 2010).

To ensure reasonable and accountable economic projections, the Ministry of Finance consults extensively with private-sector forecasters. As part of the Fiscal Transparency and Accountability Act, 2004, the Ontario Economic Forecast Council was established to provide advice on macroeconomic forecasts and assumptions. The Minister of Finance met with council members and other private-sector forecasters in the process of preparing the 2010 Ontario Economic Outlook and Fiscal Review.

COMPARISON TO THE 2010 ONTARIO
BUDGET
FORECAST

Table 6:
Changes in Key Economic Forecast Assumptions
2010 Fall Economic Statement (FES) Compared to 2010 Budget
(Per Cent Change)
  2010 2011 2012
  2010
Budget
2010
FES
2010
Budget
2010
FES
2010
Budget
2010
FES
Real Gross Domestic Product 2.7 3.2 3.2 2.2 3.2 2.5
Nominal Gross Domestic Product 4.4 5.6 5.0 4.1 5.3 4.5
Retail Sales 3.9 4.5 4.6 4.1 4.7 4.2
Housing Starts (000s) 58.0 60.0 60.0 57.0 70.0 62.0
Personal Income 3.3 3.4 4.3 4.1 4.8 4.5
Labour Income 2.7 4.0 4.6 4.2 5.2 4.7
Corporate Profits 31.0 17.0 10.5 4.9 9.0 7.5
Employment 1.1 1.7 2.1 1.7 2.3 1.8
Job Creation (000s) 73 114 139 113 155 124
Key External Variables            
Crude Oil ($ US per Barrel) 82.1 79.2 85.7 87.9 86.9 89.8
U.S. Real Gross Domestic Product 3.1 2.7 3.0 2.5 3.4 3.2
Canadian Dollar (Cents US) 96.0 96.9 97.5 98.0 98.0 98.5
3-month Treasury Bill Rate* 0.6 0.6 2.2 1.6 3.5 3.0
10-year Government Bond Rate* 3.7 3.2 4.2 3.2 4.8 4.1
  • *Government of Canada interest rates (per cent).
  • Sources: Blue Chip Economic Indicators and Ontario Ministry of Finance.
  • 1 This forecast is based on information available up to November 10, 2010.
  • 2 Based on an average of futures contracts over the week ending November 5, 2010.