Canada’s economic growth wasn’t as strong as expected in the second quarter and appears to have decelerated in July, signs that rising interest rates are cooling economic activity sooner than many forecasters anticipated.
Softening growth, however, is unlikely to deter the Bank of Canada from another oversized interest rate hike when it makes its monetary-policy decision next week, economists said.
Canada’s economy grew at an annualized rate of 3.3 per cent in the second quarter, Statistics Canada reported Wednesday, driven by strong consumer spending and business investment in inventories.
This was moderated by a fall in residential property spending and an increase in imports relative to exports, which pushed the quarterly GDP result below the Bank of Canada’s forecast of 4-per-cent annualized growth and the Bay Street consensus of 4.4-per-cent growth.
Preliminary estimates for July show that GDP declined by 0.1 per cent that month. That suggests third-quarter growth is on track to undershoot the central bank’s estimate of 2 per cent, on an annualized basis, and could mark a turning point for the Canadian economy after a period of heightened economic activity that accompanied the lifting of pandemic-related restrictions.
“While GDP growth was solid in Q2 as a whole, it was weaker than anticipated and a slow end to the quarter, plus soft start to Q3 suggest that the economy is reacting quicker to rising interest rates than the Bank of Canada may have been anticipating,” Canadian Imperial Bank of Commerce economist Andrew Grantham said in a note to clients.
The central bank has increased interest rates at four consecutive meetings since March, including a full percentage point rate hike in July, the largest single move since 1998. This campaign to raise borrowing costs is explicitly aimed at slowing down economic activity in an effort to tame runaway inflation.
While rate increases can take six to eight quarters to have a full impact, Wednesday’s GDP data show that higher borrowing costs are already squeezing rate-sensitive sectors like housing. Residential property spending contracted around 28 per cent on an annualized basis in the quarter.
That’s unlikely to push the Bank of Canada off course, private-sector economists argue. Governor Tiff Macklem signalled this month that he intends to keep raising interest rates into what economists call “restrictive territory,” where borrowing costs act as a brake on economic activity.
Financial markets are pricing in a 75-basis-point rate hike for the Sept. 7 rate decision, while Bay Street forecasters suggest that increases of 50, 75 or 100 basis points are all on the table for next week. (A basis point is one hundredth of a percentage point.)
“Inflation remains priority 1, 2, 3, and 4 for the BoC, so we don’t think today’s print will change the bank’s thinking heading into the September interest rate announcement (particularly given the strength in household spending),” Toronto-Dominion Bank rate strategists Andrew Kelvin, Robert Both and Chris Whelan wrote in a note to clients.
“We continue to look for a 75bp rate hike next week, but the softer hand-off into Q3 hints at trouble ahead,” they wrote. Looking further ahead, they suggested that the central bank may need to slow its pace of rate hikes in October, and could opt for a 25-basis-point rate hike at that point.
Royce Mendes, head of macro strategy at Desjardins Capital Markets, said that a 50-basis-point rate hike next week is now more likely.
“With the Bank of Canada already having raised rates 100bps in July, central bankers might be willing slow the pace of hikes ahead of their peers by only pushing rates up another 50bps next week. It’s possible that monetary policymakers move more than that, but there are clearly cracks beginning to form in the foundation of the economy,” he wrote in a note to clients.
While growth was weaker than expected, Canada continues to outperform peer countries, including the United States where economic activity contracted in the second quarter.
Canadian consumer spending remained robust as people bought new clothing and shoes for return to office work, and splurged on travel, restaurants and other services that have reopened as pandemic restrictions have lifted.
Business spending on inventories also boosted growth in the quarter, with a particularly notable jump in farm inventories.
“Increased production of agricultural products in the second quarter, notably wheat and canola, resulted in the largest increase in farm inventory investments since 1961, the year when quarterly data were first recorded,” Statscan said.
This was offset by a decline in residential property spending and consumer spending on durable goods. Net trade also weighed on GDP in the quarter, with a rise in imports exceeding exports.
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Mark Rendell