Canada’s Economy is Slowing Quickly as Inflation, Rising Rates Take Hold
The Canadian economy stayed flat in May, with growth slowing down as businesses continue to face supply constraints and rising interest rates, though economists say the current cycle of interest rate increases is expected to continue into the fall.
Real gross domestic product was unchanged in May after a 0.3% expansion in April, Statistics Canada reported. Growth in services-producing industries was offset by a decline in goods-producing industries, the federal agency said.
RBC assistant chief economist Nathan Janzen said the economy is hitting long-term production capacity constraints, in part because of the ongoing labour shortage. “We’re expecting growth to slow, but part of the reason for that is because the economy right now is incredibly strong,” Janzen said, noting that the economic recovery from the pandemic was much faster than expected.
A preliminary estimate for second-quarter GDP points to 4.6% annualized growth, up from 3.1% for the three months of the year.
After taking a significant hit at the onset of the pandemic, real GDP surpassed the pre-pandemic level in November 2021. “We’ve reached a very strong point in the economic cycle, earlier than expected. But the challenge from there [is] it’s just not sustainable,” he said.
The strength of the Canadian economy will have implications on the Bank of Canada’s next key interest rate decision, as it aims to cool high inflation. CIBC senior economist Andrew Grantham said solid annualized growth in the second quarter means the Bank of Canada will likely go ahead with another supersized rate hike in September. The Bank of Canada will make its next interest rate announcement on Sept. 7.
RBC is forecasting two consecutive quarters of negative growth next year, which would meet the definition of a technical recession. However, Janzen said the downturn is likely to be moderate and given early signs that global pressures on inflation are easing, the Bank of Canada may start reversing rate hikes next year.
With the inflation rate at a 39-year-high of 8.1%, the central bank said it will continue to raise the cost of borrowing to decrease demand in the economy, hoping it can bring down inflation without triggering a recession.
Janzen said he expects a half-percentage point rate hike in September, with the Bank of Canada eventually bringing its key interest to a high of 3.25% before it starts reversing its rate hikes.
According to the report released on July 29, the largest declines in May were experienced in the construction and manufacturing sectors, while transportation and warehousing saw the largest gains.
Statistics Canada said construction worker strikes in Ontario during May led to delays in projects. However, construction activity remained well above pre-pandemic levels.
Manufacturing contracted for the first time in eight months, with motor vehicle manufacturing stalled by a semiconductor chip shortage.
Transportation gains were driven by growth in air travel, which rose by 14.1%.
The results are better than expected. StatCan’s preliminary estimate suggested the economy contracted by 0.2% in May. For financial analysts on Bay Street, the report was a mixed bag. Economic growth in the April-to-June period was stronger than the Bank of Canada’s forecast of 4%. It was also markedly better than in the United States, which has posted two consecutive quarters of declining GDP, sparking a hearty debate over whether the country is mired in a recession.
On the other hand, recent months have seen sluggish growth in Canada. Consumer and business confidence is tumbling. The real estate industry has turned cold. And some high-profile companies in the tech sector are announcing layoffs.
U.S. on the Brink of Recession as GDP Contracts Again in Second Quarter
The U.S. economy shrank for a second straight quarter, raising chances of a recession, as decades-high inflation undercut consumer spending and Federal Reserve interest-rate hikes stymied business investment and housing demand.
Gross domestic product fell at a 0.9% annualized rate after a 1.6% decline in the first three months of the year, the Commerce Department’s preliminary estimate showed. Personal consumption, the biggest part of the economy, rose at a 1% pace, a deceleration from the prior period. The median projection in a Bloomberg survey of economists called for a 0.4% advance in GDP and a 1.2 % rise in consumer spending.
Two-year Treasury yields tumbled after the report reduced chances of further aggressive Fed rate increases, while U.S. stock futures remained lower and the dollar erased gains.
The details of the report showed decreases in business and government spending and residential investment. Inventories also weighed on GDP.
A key gauge of underlying demand that strips out the trade and inventories components — inflation-adjusted final sales to domestic purchasers — fell at a 0.3% pace in the second quarter compared with a 2% gain in the prior period.
The report illustrates how inflation has undercut Americans’ purchasing power and tighter Federal Reserve monetary policy has weakened interest rate-sensitive sectors such as housing. That weakness is likely to throw fuel on an already heated debate about if or when the U.S. enters a recession. While the common rule of thumb for recessions is two consecutive quarterly declines in GDP, the official determination of ends and beginnings of business cycles is made by a group of academics at the National Bureau of Economic Research.
Retailers like Walmart Inc. and Target Corp. have slashed their profit forecasts, and a slew of tech companies, including Shopify Inc., have announced plans in recent weeks to cut workers. Others, like Apple Inc. and Microsoft Corp. are slowing hiring.
Broader weakness in a labour market that’s shown only limited signs of cooling would remove a key source of support for the economy and help shape the course of monetary policy later this year.
“We think it’s necessary to have growth slow down,” U.S. Federal Reserve Chair Jerome Powell said at a news conference after another 75 basis-point hike in interest rates. “We actually think we need a period of growth below potential in order to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labour market conditions.”