News & analysis

The first estimate of Q3 GDP showed the Canadian economy contracting -0.3% QoQ, or -1.1% in annualised terms. While at first glance this would suggest the Canadian economy is now in an outright recession, Statistics Canada quietly revised up their forecast for Q2 growth from flat to +0.3%, suggesting the economy essentially yo-yoed in the middle quarters of 2023 rather than visibly contracting.

At a surface level, this does little to tip the balance for markets, which are still assessing every piece of Canadian data to determine whether a recession is currently taking place. However, given the details of the GDP report are soft and population growth was excessive in the third quarter at 0.9% QoQ, our view that the Canadian economy is either on the precipice of, or already in recession, remains.

Growth in Q3 was held up by government spending, while the private sector economy experienced a pronounced contraction 

While the headline figures will grab the attention of financial media outlets, it is actually the details of the report that are more instructive for assessing the strength of the economy. Looking at the breakdown, GDP growth in the third quarter was essentially propped up by government spending, which contributed 0.374% to overall growth, while the private sector experienced a pronounced contraction. Household spending recorded a second quarter of flat growth (+0.013% contribution), even as compensation growth remained strong at 1.3% and population growth was elevated at 0.9% QoQ.  Furthermore, weak external growth conditions and falling commodity prices weighed on exports, which dragged on GDP growth by -0.433%, while private investment also contracted. Finally, inventories were also a major drag, pulling GDP growth down -0.24% in the third quarter, but we would downplay the importance of the signal from this given the volatility of that measure drove the big revision to the Q2 data and destocking was likely exacerbated by industrial action at the start of the third quarter.

All told, while the data is seemingly net neutral for markets given the revisions and the lack of response in Canadian assets, we remain more cautious on the state of the Canadian economy. We take this view even as the monthly production-based GDP data shows the economy accelerating at the end of Q3 and beginning of Q4 – growth of 0.1% was recorded in September, while the preliminary estimate for October showed a 0.2% gain.

This is primarily motivated by our view on the labour market. The effects of higher inflation and tighter monetary policy are starting to feed through to household spending and employment conditions exposed to discretionary spending. With labour demand continuing to lag the pace of supply growth, leading to visible and more discrete measures of labour market slack increasing, wage pressures are only likely to carry on abating from here, eroding consumer confidence and weighing further on demand. We have already started to see this within the latest employment and inflation reports. While job growth remained elevated in November, it was concentrated in part-time positions and less cyclically sensitive sectors. Furthermore, core inflation pressures in Canada have come off the boil, in large part due to the weaker demand outlook as indicated by the latest consumer surveys.

The BoC needs to stop setting policy looking in the rear-view mirror

Even including the upwards revisions to Q2’s growth data, the Canadian economy remains smaller than BoC staff forecasted back in October. With the Bank fixated on setting policy depending on its theoretical assumptions of potential output, this would imply an earlier adoption of rate cuts than was previously assumed. Nevertheless, basing policy on lagged, and now visibly volatile data, relative to academic models is of dubious merit, and such a stance has already landed the BoC in hot water twice this economic cycle.

Based upon current conditions within the labour market and the progression of underlying inflation pressures, we believe the BoC will need to cut policy rates in April by 25 basis points before embarking on a quarterly easing pace back towards a neutral level of 3-3.5%. Any failure to do so risks extending the length in which the Canadian economy remains in contraction and undermining the subsequent income-led expansion thereafter.

The Canadian dollar is unmoved on today’s release as upward revisions to Q2’s data are seen netting off weakness in the third quarter

 

 

Author:
Simon Harvey, Head of FX Analysis

 

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