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Weaker GDP Should Convince the Bank to Hold on Rates

5 September 2023

After a strong start to 2023, the Canadian economy appears to be slowing rapidly. Instead of the 1.2% (annualized) growth analysts expected in Q2, the Canadian economy contracted by 0.2%. This unexpected decline in gross domestic product (GDP) aligns with the recent rise in unemployment and suggests the Canadian economy may already have fallen into a modest recession. Indeed, the Q2 economic slowdown is expected to extend through the second half of the year. 

Real GDP decreased 0.2% in June, following a 0.2% increase in May. Wildfires and droughts affected resource industries across the country, with both services-producing (-0.2%) and goods-producing industries (-0.4%) contracting in June. While early estimates suggest growth was likely flat in July, West Coast port strikes impacted trade and wildfires continued to hamper economic activity through August. While some of these factors are temporary drags, the cumulative and lasting impacts of past rate hikes are still working their way through the economy.

Factors driving a cooling Canadian economy

Housing continued to weigh on growth with a fifth consecutive quarterly decline. Housing investment fell 2.1%; new construction was down 8.2% for the quarter while renovation spending fell 4.3%. While transfer costs, including real estate commissions, land transfer taxes, legal costs and file review costs, accelerated due to the upswing in home sales during the first half of 2023, they were not high enough to offset the decline in residential investment. Since Q1 2022, residential investment is down 20 per cent as soaring borrowing costs have driven a sharp drop in spending on new home construction and renovations. 

In addition to declines in housing investment, smaller inventory accumulation, slower international exports and lower household spending largely drove the quarterly slowdown. These declines were offset in part by the surprising growth in investment in non-residential structures (10%) as well as machinery and equipment (11.1%). In other segments, government investment in capital edged lower (0.8%), while government consumption growth rebounded to 2.5% after a 3.7% decline in Q1. 

Income stood out as the positive number in Friday’s Statistics Canada data release. Income growth remained strong, with wages and salaries up 9.1% and disposable income up 10.7%. With a slowdown in spending growth and higher incomes, the savings rate moved up to 5.1%. This is generally positive for the mortgage market – it shows that consumers are more cautious and actively building up financial reserves.

The GDP number is the last key data release heading into the Bank of Canada’s September interest rate decision. The miss on growth expectations should prove highly influential in keeping the Bank on the sidelines, as it adds to signs of slowing core inflation, a softening labour market and weaker consumer demand. The Bank of Canada had pencilled in 1.5% growth for both Q2 and Q3 in its July forecasts, so activity is coming in far on the low side of official expectations. 

We expect the Bank to hold until the end of Q1 2024 when it commences rate cuts.

Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.



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