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The Canadian economy essentially flatlined in December following a 0.23% MoM increase in November, as measured on an industry basis.
Furthermore, preliminary estimates for January suggest the economy grew by 0.4% at the start of the year as activity rebounds in education services and health care and social assistance following the conclusion of strikes in Quebec. The more informative quarterly expenditure-based measure, which accounts for inventory rebuilding amongst other factors, showed the economy expanding by an average 0.2% in the fourth quarter as a whole, more than reversing the 0.1% contraction in the third quarter. This equates to an annualised quarterly growth rate of 1% in the fourth quarter and an upwards revision from -1.1% to -0.5% in Q3. This exceeds the BoC’s projections from January, which looked for an unrevised third quarter reading and flat growth in the fourth quarter.
Nevertheless, despite the stronger-than-expected headline growth prints, we are hesitant to turn bullish on the Canadian economy and to adjust our call for the BoC to begin cutting from April’s meeting following today’s data, although the bar for such a decision has arguably been raised. This is because the details of Q4’s GDP report aren’t nearly as hot as the headline data suggests.
First, despite exceeding expectations, the Canadian economy continues to grow at a below-potential pace. This burgeoning output gap is once again highlighted simply by comparing the underwhelming pace of GDP growth relative to the rise in population. The Bank’s most recent estimates place the rate of population growth at close to 3%. If anything this may be an underestimate at present given StatsCan figures showed a population growth rate of 1.1% in Q3 alone, which if maintained into Q4 would make the details of today’s GDP figures even more disappointing than they first appear. Regardless, the Q4 GDP report noted that population growth continues to outstrip increases in household spending, which rose by 0.2% in Q4. In other words a per capita recession is still underway in Canada, and the output gap has likely continued to grow. To this point, in Q2 of last year the BoC estimated that the economy’s potential growth rate was just shy of 2%, meaning the economy is currently operating with a negative output gap just north of 1% over the course of the past year.
As such, even the modestly stronger headline growth data seen for Q4 poses little threat to the current disinflation dynamics underway, meaning the BoC shouldn’t be as worried about inflation persistence as the Federal Reserve.
Not only that, but come April’s decision, we expect the BoC will revise up its estimate of potential growth in its annual re-estimation, owing to the aggressive pace of population growth in the past year and continued technological advances linked to the adoption of AI. This should see a further negative expansion in the Bank’s estimate for the output gap, which the BoC already thought was between -0.25% and -1.25% in the fourth quarter, according to the January MPR.
Second, the composition of growth in the fourth quarter remained relatively weak. Headline GDP was propped up by exports, which contributed a whopping 1.8 percentage points to the overall annualised level. By comparison, financial consumption expenditure only added 0.16 percentage points, and even though household final expenditure remained elevated at 0.526pp, this was largely oriented towards goods and away from more discretionary services items which contributed a meagre 0.132pp. Furthermore, final domestic demand, composed of final consumption and fixed capital formation, contributed -0.728pp having contracted -0.18% in the second quarter. Digging further into the details, what strength there was in discretionary sub-aggregates also scans as somewhat synthetic. Retail trade (+1.2% QoQ), which Statistics Canada noted was the largest contributor to growth in services in Q4 on an industry basis, was largely driven by health and personal care retailers (+3.8%) and motor vehicle and parts dealers (+2.7%).
Growth here largely reflects population growth given the necessity of the industries. As such, an uptick in retail trade growth doesn’t necessarily equate to stronger overall consumer demand.
All told, we think Canada’s growth model is based on weak foundations – something the Trudeau administration is desperately trying to rectify. As a result, we are inclined to hold our call for the BoC to begin easing rates as soon as April, even as the Q4 data exceeded expectations and January’s monthly growth estimates point towards a strong start to the year for the economy. That said, due to the headline level of growth in the fourth quarter, we don’t think the BoC will explicitly guide markets towards a likely cut in April, instead retaining optionality should the next inflation and two jobs reports come in unfavourably hot.
At this current juncture, however, we think below-potential growth, reduced concerns over inflation persistence, and the scope to cut rates while retaining a tight monetary stance should give the BoC confidence in cutting rates in Q2 irrespective of whether this is in April or June. Failure to do so would see the Bank conduct its third policy mistake since the start of 2022.
Authors:
Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst