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Just a week after the Bank of Canada officially internalised our base case that the economy was teetering on the edge of recession, and in fact was in outright contraction once accounting for population growth, preliminary GDP data for Q4 shows the economy tracking at an annualised rate of 1.2% QoQ.
As has been the case in recent months, the headline data once again poses more questions than answers, especially as the strong growth reading coincides with industrial action in Quebec and is concentrated in the goods sector at a time when global manufacturing is notably weak. While the usual caveats apply with the monthly growth data, such as a high degree of volatility and a track record of overpredicting the expenditure-based quarterly figures, today’s release acts to confirm our view that data issues will likely prevent the BoC from acting in the first quarter.
We continue to believe the Bank will instead await signs that core inflation pressures are starting to once again cool, more accurate quarterly growth data, and another round of business surveys before embarking on their first rate cut in April.
Despite expectations that the Canadian economy would grow by a measly 0.1% in November, the economy expanded at a faster pace of 0.2%, driven in large by a 0.6% MoM increase in goods-producing industries. Specifically of note is the manufacturing sector, which bucked the global trend and expanded at a rapid clip of 0.9% MoM. Similarly, oil and gas extraction grew by 0.3%, even as global growth concerns continued to drive energy benchmarks to multi-month lows. More representative of our view that the Canadian economy is considerably softer than the headline data suggests is services growth, which at 0.1% MoM continued to show the more limited strength implied by core levels of inflation.
Given the upside headline surprise, markets trimmed BoC easing expectations on the back of today’s release, with loonie traders also taking heart from the better-than-expected activity figures.
This comes in spite of the BoC’s own recent communications, indicating that economic growth prospects continue to look weak in the near term. Indeed, we are inclined to agree with the BoC’s judgement on this occasion. Whilst today’s numbers suggest the economy returned to growth following a contraction in Q4, any expansion was likely modest, and forward-looking indicators suggest that this strength should fade over coming months. The output gap is set to remain negative and should continue to weigh on inflation too, which in our view keeps the BoC on track to cut rates in April.
Therefore, whilst easing rate cut bets have led the loonie higher for now, seeing USDCAD fall 0.3% immediately following the data print, we think the move lower for the pair is unlikely to stick. Instead, we continue to look for USDCAD to trade higher as the underlying weakness in economic growth becomes apparent once again, meaning the current bout of loonie strength is likely to prove temporary as a consequence.
Authors:
Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst