Slightly Softer Canadian Growth Than Bank of Canada Expected

August 29, 2008

Canadian GDP rose 0.3% at a seasonally adjusted annual rate (saar) in 2Q08 versus the central bank’s assumption last month of an 0.8% increase, and first-quarter growth was revised to negative 0.8% from negative 0.3% reported three months ago.  As a result, on-year growth slid to merely 0.7% from 1.6% in 1Q08 and 2.8% in both 4Q07 and 2Q07.  Moreover, activity lost momentum as 2Q unfolded.  Monthly GDP has posted a 0.4% gain in April after which such dipped 0.1% in May and then recouped that same 0.1% in June.  Energy-sector output has dropped for five consecutive months, and industrial production fell in four of the last five months.  While Canada has so far averted back-to-back declines in GDP, bear in mind that recessions can and have historically been declared even when GDP failed to record any on-year declines.  In a separate report, producer prices rose 0.4% in July, a fourth as much as in June, but on-year PPI inflation accelerated further to 6.8% from 5.8% in June, and non-oil PPI inflation more than doubled to 1.6% from 0.7%.  This news arrives less than a week before the central bank’s interest rate announcement next Wednesday.  I expect officials to debate the merits of a rate cut but to defer such on concern about inflation.

In the second quarter, personal consumption growth slowed to 2.4% saar from 3.1% in 1Q, and exports (-5.9%), residential investment (-3.9%) and non-residential business investment (-1.4%) contracted.  Net foreign demand exerted a 2.9 percentage point drag on the GDP growth rate.  That negative force as expected was mitigated by a 4.7% jump in government spending and a 1.2 percentage point positive growth contribution from inventory building, which had been a depressant in 1Q.  Canada has achieved economic growth of less than 1% saar for three straight quarters, far below the potential growth trend of 2.7%.  Canada’s excess supply is projected by Bank of Canada officials to increase further during the second half of 2008 but to start narrowing thereafter.  Last month, officials were assuming the full restoration of full capacity around mid-2010.  Today’s data suggest that will not occur until somewhat later, say by end-2010.  That shift ought to justify another interest rate cut in 2008.  My baseline forecast does not embody a move as soon as September 3rd, but I would not be shocked if officials took such action, either.  One reason to act now is the increasing likelihood that Prime Minister Harper might call elections for October.  In any case, central bank officials, even if they keep a 3% overnight money rate target, are likely to herald the probability of a rate reduction later this year.



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