Anticipating a Return to Positive Canadian Growth and a Bigger External Surplus

August 27, 2008

The second-quarter current account will be reported Thursday at 08:30 EDT (12:30 GMT) followed at the same time but on Friday by quarterly national income account statistics and June monthly GDP.  Higher commodity export prices especially of energy generated a swift recovery of the current account surplus from less than 0.5% of GDP in the second half of 2007 to 1.4% of GDP in the first quarter of this year.  The merchandise trade surplus widened by an additional C$ 1.9 billion in 2Q08, suggesting a further improvement of the current account surplus to about 1.6% of GDP last quarter.  In 2006-7, by comparison, that ratio averaged some 1.2%.

Canadian quarterly real GDP growth weakened progressively in 2007 from 4.1% at a seasonally adjusted annual rate in 1Q to 3.9% in 2Q, 2.3% in 3Q and 0.8% in the final quarter, and then growth shocked analysts with a negative print of -0.3% saar in 1Q08.  in that first quarter of 2008, private consumption (3.2% saar), non-residential business investment (2.2%) and public consumption (2.6%) had each expanded decently.  However, residential investment and a rundown of business inventories had exerted  a combined drag on growth of more than 5.0 percentage points.  The second quarter will not see a repetition of these huge negatives, but the positive elements of growth in 1Q also will be smaller.  On balance, a return to positive growth seems probable, but the figure will be only about 1% saar, more or less, giving Canada a fourth straight quarter of less-than-trend economic growth. Monthly GDP, which dipped 0.1% m/m in May, also likely returned to the black.  In June retail sales rose 0.5%, wholesale sales climbed 2.0%, factory sales and inventories grew by 2.1% and 0.6%, but export volumes fell 1.4%.  Housing starts were also softer.

According to conventional wisdom, the weaker-than-expected development of economic growth since mid-2007 reflects America’s difficulties, and Canada is not out of the woods as attested by July labor market data showing the biggest monthly drop in jobs (55.2K including a 41K loss of factory workers in Ontario) since 1991.  Between December and March, Canadian monetary officials reduced their overnight money target by 150 basis points to 3.5%, and a weakening exchange rate augmented this shift in monetary policy.  Higher CPI inflation of 3.4% y/y in July has more recently frozen monetary policy, and the target interest rate is expected to hold at 3.5% after next week’s Bank of Canada policy meeting.

Not everyone thinks U.S. developments explain Canada’s slowdown well.  Professor Stephen Gordon of Laval University in Quebec City presents evidence that suggest other factors have been more influential.  Click here to read Gordon’s argument.

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