Part 3: British Columbia Economic
Review and Outlook¹

Summary

• Growth in British Columbia is strong, supported by a low unemployment rate, robust domestic demand and strong business investment.
• Growth is expected to moderate over the medium-term, but remain robust.

Internal risks to the economic forecast

• The mountain pine beetle epidemic
• A shortage of skilled workers in the construction industry

External risks to the economic forecast

• The Canadian dollar rises significantly above the current forecast
• A slowdown in the US economy
• Natural gas prices falling significantly below forecast

1	Reflects information available as of February 10, 2006. All annual and quarterly references are for the calendar year.

Recent Developments

Following estimated growth of 3.6 per cent in 2005, the British Columbia economy is forecast to grow 3.3 per cent in 2006 and 3.1 per cent in 2007. Consistent with government's prudent forecasting practices, this forecast is slightly more conservative than that of the Economic Forecast Council, a group of independent private sector economists who provide advice to the Minister of Finance on the provincial economic outlook.

The Economic Forecast Council forecasts growth in British Columbia of 3.6 per cent in 2006 and 3.2 per cent in 2007 on average. Over the 2008 to 2010 period, the Council expects the British Columbia economy to grow 3.2 per cent per year on average, while the Ministry of Finance expects growth to average 3.1 per cent over the medium term (see Chart 3.1). A topic box at the end of Part Three reports on the consultation with the Economic Forecast Council.

Employment in BC showed strength for most of 2005, posting annual growth of 3.3 per cent. The unemployment rate hit 4.9 per cent in November, its lowest rate in over three decades. For the year, the unemployment rate averaged 5.9 per cent in 2005. Meanwhile, employment in the province was unchanged in the first month of 2006 compared to December 2005, with 2,166,900 people employed. The unemployment rate in January was also unchanged at 5.1 per cent.

Following double digit growth for four years, housing starts grew 5.3 per cent in 2005 to average 34,667 units. Housing starts in BC remain at high levels, supported by strong migration to the province that has offset the impact of rising interest rates. In January 2006, BC housing starts came in at 35,700 units.

Retail sales continued to post strong growth in 2005, with retail sales in BC up 6.1 per cent on a year to date basis to November, reflecting increasing migration and strong consumer confidence.

Manufacturing shipments declined during the first part of 2005 due to weak shipments of wood and paper and lower spruce pine fir prices. However, manufacturing shipments were up 1.5 per cent year to date to November as shipments of wood and primary metals regained ground in the final quarter.

The value of merchandise exports rose 10.0 per cent in 2005, mainly due to robust energy exports and higher natural gas prices. Meanwhile, forestry exports declined 7.1 per cent last year due to lower spruce pine fir prices and the high Canadian dollar.

Non residential building permits climbed strongly in the first half of 2005 but fell back somewhat in the last two quarters of 2005. Nevertheless, the strength in non residential permits earlier in the year resulted in an increase of 54.7 per cent in 2005. Overall, strength was seen in the institutional and government as well as the commercial components of non residential building permits.

The performance of key BC economic indicators in recent quarters is presented in Table 3.1.

The Outlook for the External Environment

The U.S. economy posted strong growth for most of 2005, with annualized growth of 4.1 per cent in the third quarter, slowing to 1.1 per cent in the fourth quarter. Slower growth in the final quarter was due to substantially weaker growth in real consumer spending, business investment and residential investment. Federal government spending declined in the October to December period of 2005 due to a drop in defense spending related to timing issues. Strong imports growth in the fourth quarter also contributed to the lower real GDP growth, while exports growth was relatively unchanged.

Overall, the U.S. economy grew by 3.5 per cent in 2005, down from 4.2 per cent in 2004. The U.S. economy created 2.028 million jobs in 2005, more than the 1.436 million recorded for 2004. Retail sales in the U.S. rose 7.3 per cent in 2005. High energy prices resulted in inflationary pressures in the U.S. with the annual consumer price index up 3.4 per cent in 2005, from 2.7 per cent recorded in 2004. However, core inflation remains under control so far, as the energy price spike following the hurricanes in the Southern U.S. did not pass through into broader inflation. Housing starts in the U.S. grew 6.0 per cent in 2005 to reach 2.1 million units. The U.S. housing market has slowed in recent months and analysts anticipate further weakness as higher mortgage rates, high house prices and saturated demand act as a drag on the overall housing market.

After the 3.5 per cent growt h seen in 2005, the January Consensus Economics survey of private sector economists expects U.S. real GDP growth of 3.4 per cent in 2006 and 3.1 per cent in 2007. Over the past year, the consensus outlook for 2006 has hovered around a narrow range of 3.2 per cent to 3.4 per cent. Most analysts are expecting growth in the U.S. to moderate going into the second half of 2006 due to the impact of sustained high oil prices, higher interest rates and slowing consumer spending growth as the housing market moderates.

In order to reflect the risks surrounding the U.S. economic outlook, the Ministry of Finance's growth assumptions are somewhat lower than the consensus. For 2006, the Ministry of Finance assumes U.S. economic growth of 3.0 per cent, compared to the current 3.4 per cent consensus. U.S. growth is expected to moderate to 2.9 per cent in the Ministry of Finance forecast for 2007, while the January consensus survey predicts somewhat higher growth of 3.1 per cent. Over the medium-term, the Ministry of Finance assumes that the U.S. economy will grow at a rate of about 3.0 per cent per year. The uncertainty surrounding the sustainability of U.S. economic growth in 2006 and 2007 stems from a number of factors, including slowing in the U.S. housing market as interest rates rise, the impact of high energy prices and the fiscal and current account deficits.

A rebound in exports, strong commodity prices and continued strength in domestic demand supported growth in the Canadian economy in 2005. Real GDP in Canada grew at an annualized rate of 3.4 per cent in the second quarter and 3.6 per cent in the third quarter of 2005. The Canadian economy created 222,700 jobs in 2005, an increase of 1.4 per cent. Towards the latter part of 2005 the unemployment rate fell to its lowest level in over 30 years, and averaged 6.8 per cent for the year.

Strong commodity prices supported the trade sector with the value of merchandise exports up 5.8 per cent in 2005. Despite the appreciation of the Canadian dollar relative to the U.S. dollar, manufacturing shipments in Canada grew 3.4 per cent in the first eleven months of 2005 compared to the same period in 2004. Overall domestic demand in Canada remained healthy last year, with retail sales posting growth of 6.3 per cent during the first eleven months of 2005 compared to the same period a year ago. Low mortgage rates, healthy labour markets and steady income growth continued to support the Canadian housing market in 2005, with housing starts totaling 225,481 units, a 3.4 per cent decline from 2004. While the growth in housing starts declined in 2005, the level of housing starts remained high and posted their second highest level since 1988.

The Consensus Economics survey has kept their 2006 Canadian growth expectations steady at 3.0 per cent for the past four months. Supported by recent positive economic data releases for the labour market and retail sales, forecasters expect consumer spending to support growth going into 2006. The Ministry of Finance assumes a more conservative growth rate of 2.8 per cent in 2006.

For 2007, several forecasters have adjusted down their Canadian forecasts in recent months. As well, the Bank of Canada Monetary Policy Report Update, released on January 26, 2006, noted that the risks were to the downside for 2007 and beyond as "the unwinding of global imbalances could involve a slowdown in world economic activity". The January Consensus survey calls for growth of 2.7 per cent for 2007. The Ministry of Finance forecast assumes that the Canadian economy will grow by 2.6 per cent in 2007.

The Japanese economy performed above initial expectations last year as domestic demand strengthened as the year progressed. Export growth was also strong, helped by the yen's weakness versus the U.S. dollar and China's booming economy. Analysts expect an improving job market and robust housing activity to support further strengthening in domestic demand. Corporate sector resilience and continued export growth are expected to support growth in 2006. Following estimated growth of 2.5 per cent in 2005, the January Consensus Economics survey predicts economic growth in Japan of 2.2 per cent in 2006 and 2.1 per cent for 2007. The Ministry of Finance is assuming lower growth of 1.8 per cent in 2006 and 1.7 per cent in 2007, to reflect uncertainty about how broadly based growth in the Japanese economy will be. This uncertainty is highlighted by the wide range of private sector forecasts.

Germany's economy has been showing signs of improvement recently with accelerating investment in machinery and equipment, rising business sentiment and growth in industrial production. However, going forward analysts are uncertain as to whether these improvements will translate into more jobs and higher consumer spending. Overall growth prospects for Europe remain subdued in the near term due to the uncertainty of Germany's economic recovery. The Consensus Economics survey in January predicts growth of 1.9 per cent in Europe for 2006 and 1.8 per cent in 2007. The Ministry of Finance forecasts slightly lower growth of 1.7 per cent in 2006 and 1.8 per cent in 2007 for Europe.

According to preliminary estimates, China's economy grew 9.9 per cent in 2005, driven by strong exports. In July of 2005, China delinked its currency from the U.S. dollar, resulting in a revaluation of 2.1 per cent. The Chinese Yuan now floats within a very narrow band against a basket of currencies from the country's major trading partners, and some analysts are expecting authorities to maintain a moderate rate of Yuan appreciation against the U.S. dollar in 2006. Domestic demand is expected to be the main driver of economic growth in China in 2006 as export growth eases. Banking sector reforms and the downsizing of less efficient state owned enterprises continue to be important elements to China's economic stability. Blue Chip Economic Indicators, a monthly survey of about 50 leading business economists, was forecasting growth in China of 8.6 per cent in 2006 and 8.2 per cent in 2007 in their January survey.

Financial Markets

The Federal Reserve Board raised the intended federal funds rate 25 basis points on January 31^st, 2006, bringing the key interest rate to 4.50 per cent. The federal funds rate has been raised 25 basis points at every meeting since June of 2004 for a total of 350 basis points, as the Fed steadily removed monetary stimulus from the U.S. economy. In their latest announcement, the Fed indicated that the expansion in economic activity in the U.S. appears solid despite recent economic data releases and that "some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance".

The Bank of Canada raised the target overnight rate 75 basis points over the course of 2005, ending the year at 3.25 per cent. In their January 24, 2006 interest rate announcement the Bank of Canada raised its target for the overnight rate another 25 basis points to 3.50 per cent. The Bank stated that Canadian and global economies are evolving in line with their expectations and that the, "risks to the Bank's projection remain balanced for 2006 and tilted to the downside through 2007 and beyond." They also indicated that further modest reduction in monetary stimulus would be required over the medium term and that consumer price inflation and core inflation should return to the 2.0 per cent target by the first half of 2007.

Outlook

Consistent with private sector forecasts, the Ministry of Finance assumes that the Federal Reserve will raise the federal funds rate in the first quarter of 2006, and then move to the sidelines as inflationary pressures ease and growth moderates. Going into 2007, the average of the private sector anticipates a decline in interest rates as the U.S. economy slows.

Private sector forecasters (see Table 3.3) expect the Bank of Canada to continue raising the overnight target rate in the first half of 2006, before going on hold until 2008 as growth in the Canadian economy moderates. The private sector average reflects the Bank of Canada's sentiment that a further reduction in monetary stimulus will be required to keep inflation in check.

Private sector forecasters expect the Canadian three month treasury bill rate to average 3.9 per cent in 2006, and 4.1 per cent in 2007. Ten year government of Canada bonds are forecast to average 4.7 per cent this year and 4.9 per cent in 2007. The Ministry of Finance outlook is based on the average of six private sector forecasts as of January 5, 2006.

The appreciation of the Canadian dollar continued in 2005, with the value of the Canadian dollar averaging 82.5 cents US for the year, up from 76.8 cents US in 2004. After weakness earlier in the year, the Canadian dollar appreciated in the second half of 2005 and hit a high of 87.7 cents US on February 1, 2006.

Outlook

High energy prices, rising Canadian interest rates and continued weakness in the U.S. dollar (weighed down by the twin deficits) are expected to support the Canadian dollar in 2006. However, appreciation in the Canadian dollar may be tempered by softening non-energy commodity prices.

Private sector forecasters expect the Canadian dollar to average 86.2 cents US in 2006, falling to 85.2 cents US in 2007. The Ministry of Finance exchange rate outlook is based on these private sector averages (see Table 3.4). The Canadian dollar is expected to level out at 85.0 cents US for the 2008 to 2010 period.

The British Columbia Outlook

The outlook for 2005 improved over the course of the year, as robust employment and income gains translated into higher consumer spending. Investment posted strong growth and exports were also higher than expected. The Ministry of Finance estimates that the BC economy posted growth of 3.6 per cent in 2005, ahead of last year's February 15 budget forecast of 3.1 per cent and the subsequent September Update forecast of 3.4 per cent.

For 2006, the Ministry of Finance expects economic growth in British Columbia, at 3.3 per cent, to outperform Canadian growth in 2006. Over the medium term, economic growth in BC of 3.1 per cent is expected, reflecting continuing robust investment, consumer spending and export growth. This outlook is consistent with, but slightly lower than the Economic Forecast Council.

Table 3.6 summarizes the Ministry of Finance's outlook for key economic indicators, while Tables 3.8.1 to 3.8.4 at the end of Part Three provide additional detail on the economic forecast.

The Labour Market

Employment in British Columbia was robust in 2005 averaging 2,130,500 persons employed, an increase of 3.3 per cent from 2004. The economy created 67,800 jobs in 2005, 63,100 of which were in full time employment and 4,800 in part time employment. Job growth in British Columbia was broadly based, with both goods and services sectors expanding in 2005.

The unemployment rate in British Columbia averaged 5.9 per cent in 2005, down from 7.2 per cent in 2004 as growth in employment outweighed growth in the labour force. The unemployment rate hit 4.9 per cent in November, its lowest rate in three decades.

Outlook

Employment is forecast to increase by 2.0 per cent in 2006, adding about 41,000 jobs to the BC economy. In 2007, an additional 43,000 jobs are expected to be created in BC, an increase of 2.0 per cent as well.

The labour force is expected to grow at about 1.8 per cent in 2006 and 1.9 per cent in 2007. As the labour force is expected to grow at a slower pace than employment for those two years, the unemployment rate is forecast to fall to 5.7 per cent in 2006 and 5.6 per cent in 2007. Over the medium term, the unemployment rate is forecast to level off at around 5.5 per cent.

Domestic Demand

Consumer Spending and Housing

Retail sales continued to post strong growth in 2005, with the value of total retail sales in BC up 6.1 per cent in the first eleven months of 2005 relative to the same period of 2004. The high level of housing activity in 2005 supported retail sales in the province, as much of the strength was seen in home furnishings, home improvement stores and home electronics and appliances. However, the largest contributor to retail sales growth in 2005 was the value of fuel sales, reflecting higher market prices for gasoline.

British Columbia housing starts totaled 34,667 units in 2005, a 5.3 per cent increase over the previous year. Increased migration and robust job creation supported housing starts in 2005. In the first month of 2006, housing starts came in at 35,700 units.

Outlook

The forecast for inflation adjusted consumer spending on goods and services calls for growth of 3.4 per cent in 2006 (see Table 3.8.1 at the end of Part Three). Steady growth in employment and rising incomes in British Columbia will support consumer demand for goods and services this year. In 2007 and beyond, growth of 3.1 per cent is expected in real consumer spending on average, reflecting steady income growth and low levels of unemployment in the province. Retail sales are forecast to rise 5.7 per cent in 2006, followed by growth of 5.1 per cent in 2007.

Although the level of housing starts will remain high, rising interest rates, saturated demand and rising house prices are expected to cool housing starts growth in British Columbia over the forecast period. Housing starts are forecast to total 32,000 units in 2006, falling to around 31,700 units in 2007. Over the medium term, housing starts are forecast to decline gradually reaching 30,400 units by 2010.

External Trade and Commodity Markets

The value of BC's merchandise exports rose 10.0 per cent in 2005, mainly due to robust energy exports. Energy exports grew 68.5 per cent due to a combination of price hikes and increased demand. Electricity exports surged at the end of 2005, as the effects of the hurricanes in the southern U.S. resulted in higher energy prices and increased demand. Also, the value of natural gas and coal exports was up considerably in 2005 compared to 2004.

Lower spruce pine fir prices, and the continued effect of a higher Canadian dollar, contributed to a 7.1 per cent decline in forestry exports last year. The spruce pine fir price averaged US$355 in 2005, down almost 10 per cent from US$394 in 2004. The price of hemlock baby squares also fell last year, down 12.1 per cent to average US$540 in 2005. In contrast, the value of non forestry merchandise exports increased 24.7 per cent in 2005.

Canadian natural gas prices continued to be volatile over the course of 2005, with the lowest price of $5.5C/GJ in February being followed by an estimated high of $11.1C/GJ in December. Natural gas prices rose significantly in the second half of the year and into December when colder than normal weather raised concerns about winter supply.

Coal prices more than doubled last year, driven largely by demand from China's rapidly growing economy. Analysts are keeping an eye on the coming expansion of India's steel sector and the potential impact that may have on the demand for coal and hence coal prices.

Prices for metals also strengthened in 2005. Prices for molybdenum, zinc, copper, lead and aluminum posted double digit growth in 2005 while gold and silver also posted strong price gains.

Outlook

Real exports of goods and services are expected to increase 1.9 per cent in 2006. This is somewhat lower than the 2.8 per cent growth estimated in 2005, reflecting the higher Canadian dollar, easing external demand and continued weakness in the BC forestry sector. Real export growth is forecast to improve over the medium term, consistent with economic growth in BC's trading partners and increased service exports related to the 2010 Olympics. Over the 2007 to 2010 period, export growth is expected to average 4.0 per cent per year.

Export prices are expected to decline in 2007, led by lumber prices returning to their medium term levels. Spruce pine fir prices are expected to average US$338 per thousand board feet in 2006 and US$300 through the remainder of the forecast period. Natural gas prices are forecast to decline gradually, reaching C$6.24/GJ by 2009/10.

The average price of British Columbia goods and services exports is forecast to rise just 0.4 per cent in 2006, as the strength in energy prices are largely offset by a decline in the price of lumber, BC's largest export, and slowing metal prices. The average export price is expected to pick up gradually over the medium term as commodity prices stabilize and the Canadian dollar remains around 85.0 cents US.

Business and Government

Total business investment (including residential) adjusted for inflation is estimated to have expanded by 5.9 per cent in 2005, following robust growth of 10.6 per cent in 2004. Most of the growth in business investment was driven by strong investment in machinery and equipment and non-residential construction.

Business machinery and equipment investment (adjusted for inflation) benefited from the higher Canadian dollar, rising an estimated 8.5 per cent in 2005, as costs were lower for industries importing equipment from the U.S. This follows the 18.3 per cent increase in machinery and equipment investment seen in 2004.

Business non-residential construction investment (adjusted for inflation) turned around in 2005, with estimated growth of 6.2 per cent following a 4.4 per cent decline in 2004. This measure represents inflation adjusted spending by businesses for construction of industrial, commercial and institutional buildings, highways, bridges, sewages systems and various other projects.

Another often quoted measure of non-residential construction activity in BC is Statistics Canada's measure of real investment in non residential building construction. This measure differs from the one mentioned above in that it includes both government and business investment (as opposed to just business investment), and measures construction investment on buildings only (and does not include investment on highways, bridges, sewages systems and various other projects). In 2005, real investment in non residential building construction was up 18.8 per cent, following a 3.4 per cent increase in 2004.

Meanwhile, real residential investment posted estimated growth of 4.1 per cent in 2005, slower than the double-digit growth seen in 2004. Corporate profits in British Columbia grew an estimated 7.4 per cent in 2005 following a strong 38.9 per cent gain in 2004.

The strength in the non-residential construction sector last year has led to some concern surrounding a shortage of skilled workers in the industry and the resulting upward pressure on wages. Average hourly earnings in the non residential construction sector increased 4.1 per cent over the January to November period of 2005, relative to the same period of 2004.

However, wages are not the only driver of construction costs, as overall building material costs have also risen. In Vancouver, the overall construction price index for non-residential buildings (a measure of costs facing the construction industry in Vancouver) increased 7.5 per cent during the first nine months of 2005 relative to the same period in 2004 (see the topic box on page 100).

Local, provincial and federal government combined spending in BC is estimated to have increased 5.0 per cent in 2005 in inflation adjusted terms.

Outlook

Total investment in British Columbia is forecast to grow 6.4 per cent in 2006, moderating to 3.1 per cent in 2007. This growth reflects public sector investment in capital projects as well as strength in machinery and equipment and non-residential investment. Over the medium term, total investment in British Columbia is expected to grow around 4.6 per cent per year on average. Strong non residential investment is expected to be a significant growth driver over the medium term, rising 6.6 per cent per year on average from 2008 to 2010. Investment in machinery and equipment is also forecast to post strong growth over the medium term, as firms take advantage of the higher Canadian dollar to import equipment from the U.S. at a lower cost.

Combined spending by the three levels of government in inflation adjusted terms is expected to grow 2.8 per cent in 2006 and increase 1.9 per cent in 2007. Over the medium-term, inflation adjusted government spending is forecast to rise 1.4 per cent on average per year.

Inflation

Consumer price inflation in British Columbia averaged 2.0 per cent in 2005, slightly below the Canadian average rate of inflation of 2.2 per cent. BC's rate of inflation started the year at 2.3 per cent, falling to a low of 1.5 per cent in May and June as gasoline prices subsided from earlier highs. However, by September the rate of inflation picked up to 2.4 per cent in BC as energy prices spiked in the aftermath of the U.S. hurricanes and gasoline prices resumed their upward growth. By December the rate of inflation fell back to 1.8 per cent as gasoline prices subsided.

The overall rate of inflation in Canada followed a similar pattern in 2005, spiking to a high of 3.4 per cent in September, but returned to 2.2 per cent growth by December as gasoline prices fell back to pre Katrina levels.

Outlook

Consumer price inflation in British Columbia is expected to average 2.2 per cent in 2006 and 2.1 per cent over the 2007 to 2010 period. The Canadian rate of inflation is expected to average 2.0 per cent per year over the medium term, in line with the Bank of Canada's inflation target.

Risks to the Economic Outlook

The economic outlook has risks on both the upside and downside. The most significant risks to the British Columbia outlook remain the volatility of the Canadian dollar and sustainability of U.S. economic growth.

The British Columbia economy could grow faster than forecast if:

• The Canadian dollar falls significantly below the current forecast.
• The U.S. economy performs better than anticipated.
• A lasting resolution to the softwood lumber dispute is reached; alongside growing U.S. demand, this would provide an opportunity for further growth in British Columbia's forest industry.
• British Columbia business confidence and investment strengthen further; this would provide a base for stronger economic growth in the province.
• Interprovincial net in migration strengthens further; this would generate additional demand for goods and services and boost economic growth.
• Visitors to BC increase more than expected as Vancouver gains further international recognition as a tourism destination through promotion of the 2010 Winter Olympics.

Alternatively, the British Columbia economy could grow slower than forecast if:

• There was a slowdown in world economic activity.
• The Canadian dollar movements become increasingly volatile or the dollar appreciates rapidly above the current forecast.
• Oil prices rise and are sustained at a high level, dampening North American growth prospects.
• Interest rates in the U.S. and Canada rise more quickly than forecast.
• Commodity prices decline more sharply than forecast or become more volatile.
• The recent monetary tightening, as well as the effects of high oil prices on China, slows the Chinese economy significantly.
• Geopolitical uncertainty accelerates due to events in the Middle East or further terrorist attacks.
• Tourism in BC slows, for example due to fears of an Avian Flu outbreak.