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The Canadian economy continued to flatline in August, as a slight increase in the services sector (+0.1% MoM) was netted off by a contraction in goods (-0.2%). This marked the second successive month where growth came in flat, with the month before exhibiting a slight contraction.
Signs of weakness in the Canadian economy have only grown clearer in recent months despite elevated population growth, increasing our confidence that the BoC has hit its terminal rate and, if anything, have raised the risk that the Bank may have overtightened policy. This could open the debate for rate cuts as soon as Q1 of next year, even if the Bank wants to delay this possibility by stressing the progress in cooling inflation has recently stalled.
Irrespective of whether September’s GDP print tips the Canadian economy into a technical recession, which is an academic debate at best given StatsCan’s preliminary estimate points to a negligible contraction at most, the stagnant pace of growth means the economy continues to underwhelm the BoC’s forecasts, which foresee an annualised growth rate of 0.8% QoQ in the third quarter.
With evidence from the Bank of Canada’s consumer and business surveys indicating that discretionary spending, hiring intentions, and investment intentions are only set to decline further, we anticipate that the economy will enter a somewhat more pronounced recession around the start of 2024, which would put pressure on the BoC to begin cutting rates before the Federal Reserve. While we do expect core inflation pressures to subside as growth sours further, the risk of stagflation is nevertheless real. In such an environment, the BoC may still hike once more, but it would only raise the odds of a more severe downturn.
The breadth of growth in August was narrow, with the consumer showing specific weakness
Dialling into August’s industry growth data, while the top-line figures show that the divergence between goods and services continued in August, the breadth of growth within those sectors adds further confirmation to the disparity. Goods-producing industries are clearly in recession territory as they have contracted by 2% over the past 12 months, and 3 of 5 showed further negative monthly readings. Manufacturing (-0.6%) fell for the fourth time in five months as utilities (-1.0%) fell for the fifth consecutive month and soft commodity producers including agriculture (-3.2%) approached a full year of a downward spiral. Construction (0.0%) merely halted its decline, but was -1.7% softer than a year ago.
The only goods-producing industry to show positive growth was mining, quarrying, and oil and gas (+1.2%), which have now fully recovered from the effect of forest fires in May.
Even in the stronger services sector, which is up 1.9% YoY, breath was not great. In fact, more services industries contracted than grew, with 6 posting positive growth readings, 7 posting negatives, and 2 showing no change. Wholesale trade (2.3%) was the main driver of growth within the services sector, with its outsized contribution keeping the services sector as a whole in positive territory. Transportation and warehousing (+0.8%) also rebounded, with the negative impact of July’s port strikes in BC now having been fully recouped. But the consumer slowdown is quite evident in retail trade (-0.7%) and hospitality (-1.8%). Retail trade has now weakened for a third consecutive month, while hospitality recorded its third negative reading in four months.
Growth in wholesale trade, mining, and energy production prevented the Canadian economy from contracting in August
Although StatsCan doesn’t provide much information with their preliminary estimates, they do note that decreases in mining, quarrying, and oil and gas extraction alongside utilities were partially offset by increases in the construction and public sectors.
Reading between the lines, this indicates that the consumption picture remained weak towards the end of September. With the BoC’s Q3 surveys suggesting that consumers are tightening their belts further and firms are set to hire fewer workers going forward, the outlook for consumption in Canada remains weaker than headline growth statistics suggest. This is especially the case given that abnormally high population growth, supported in large part by firms’ demand for temporary foreign workers, has added to aggregate demand and prevented a recession so far this year.
As consumption slows further, this will likely result in core inflation pressures continuing to moderate into year-end.
In conjunction with emerging slack within the labour market, this should open the debate over BoC beginning to ease back to neutral policy rates as soon as Q1 next year, far earlier than swap markets are anticipating given the first full rate cut isn’t priced until the end of 24Q3.
Authors:
Simon Harvey, Head of FX Analysis
Jay Zhao-Murray, FX Market Analyst