Canada’s economy grew in the second quarter, but momentum is slowing as the Bank of Canada’s aggressive interest-rate hikes take some of the heat out of the economy. Gross domestic product (GDP) from April to June increased at an annual rate of 3.3%, compared to 3.1% for the first quarter of 2022, Statistics Canada said on Aug. 31. The agency’s monthly estimate for July showed a contraction of 0.1%.

Here’s what you need to know:

Is 3.3% growth considered good?

The Bank of Canada in its July Monetary Policy Report last month forecast that output would grow by 4%, while Bay Street economists expected the economy to grow by 4.4%.

Statistics Canada’s data showed Canada’s economy expanded in the face of rising inflation, a tight labour market and excess demand. But its negative reading for July, along with forecasters’ missed estimate, indicate growth is waning and could further weaken in the last half of the year. Still, output is higher than the central bank’s “potential” growth rate of 2%, the threshold at which it believes the economy can expand without fuelling inflation.

“The Q2 GDP reading was likely the last ‘above-trend’ increase of this economic cycle. The bulk of GDP growth in Q2 came earlier in the quarter,” Nathan Janzen, assistant chief economist at Royal Bank of Canada, said in a note. “We continue to expect growth to be slower over the second half of the year with the economy slipping into a ‘moderate’ recession in 2023.”

What drove the growth?

Despite inflation being at levels not seen in decades, household spending was one of the biggest contributors to economic growth. In the second quarter, annualized expenditures rose 9.7% amid increased spending on clothing and footwear. That’s partly because rising wages boosted household incomes. Overall disposable household income increased at a quarterly rate of 1%.

The savings rate fell to 6.2%, on a quarterly basis, from 9.5% in the first quarter. But household net savings are still more than double what they were at the end of 2019. That, combined with rising incomes and an economy free from COVID-19 lockdown restrictions, led more people to travel and dine out.

Business investment also played a role. Amid strong consumer spending and high prices for commodities, more businesses stockpiled inventories, the biggest contributor to output at $47 billion. Demand for services, especially travel, helped bolster spending on machinery and equipment, up nearly 14% on an annualized basis. 

Nominal GDP, which doesn’t strip out inflation, rose close to 18%, annualized, in the quarter. “Recall that nominal GDP drives things like personal income, corporate profits and government revenues,” Bank of Montreal chief economist Douglas Porter said in a note. “For a Bank of Canada that is laser-focused on inflation, the moderate miss in real GDP is almost meaningless when nominal spending is barreling ahead … deep into double-digit terrain.”

A slowdown in other sectors of the economy indicate the central bank’s rate hikes are beginning to work. For example, annualized investment in the housing market dropped more than 27% in the quarter. Trade also dragged on growth, with imports up more than 30%, annualized, while exports only grew at an annual rate of 11%.

What does it mean for inflation?

GDP expanded at a slower rate than forecasters expected, but the economy is still too heated for the Bank of Canada’s liking.

Governor Tiff Macklem kicked off an aggressive rate-tightening cycle in March to stamp out rapid price growth. In July, the Governing Council issued a rare, 100-basis-point increase after the consumer price index reached 8.1% in June. CPI receded to 7.6% in July.

But we should expect more rate hikes. The central bank is “determined” to bring an end to high inflation and rebalance supply and demand, Macklem wrote in a column for the National Post. “We know our job is not done yet — it won’t be done until inflation gets back to the 2% target.”

Markets expect the Bank of Canada to increase the interest rate by 75 basis points in September.

What’s the outlook for the third quarter?

With July’s negative reading, economists are bracing for softer growth in the second half of the year. “It now looks likely that GDP growth will slow to a little less than 1% annualized this quarter, leaving it well below the bank’s forecast of 2%,” Capital Economics senior economist Stephen Brown said by email.

“The bottom line is that the economy is slowing faster than most forecasters expected although, with the labour market still very tight and wage growth likely to accelerate, we doubt that this will be enough to stop the Bank of Canada from raising its policy rate by another one-per-cent point over the next two meetings.”

Source: Globe and Mail
Source: Financial Post
Source: The Star
Source: Statistics Canada