A Ho-Hum End to 2017 for the Canadian Economy

The Canadian economy closed out 2017 on a ho-hum note as GDP rose 1.7% in Q4 (Q/Q, SAAR), roughly matching the previous quarter’s revised pace of 1.5%. Healthy gains in export prices led to significant gain in nominal output, which rose a robust 6.5%. Over 2017 as a whole, real GDP expanded by 3.0%, while nominal growth was a brisk 5.3% – the strongest pace since 2011.

Leading growth higher was investment, which climbed 9.6% in aggregate. Investment in residential investment surged ahead, up 13.4%. New construction gained 12.7%, while ownership transfer costs surged 42.8% likely reflecting a recovery from prior quarters as well as the pull-forward of activity ahead of January’s changes to mortgage underwriting rules. Non-residential investment also came in strong: non-residential structures investment rose 5.4%, while investment in machinery and equipment rose 12.7%. Government investment was up 10.3%.

Canadian consumers cooled their jets somewhat as household consumption slowed somewhat, to 2.1%. The pace of goods spending ticked down slightly, to 1.6% (Q3: 1.2%), while spending on services slowed to 2.5% from 5.7% previously.

Trade took a significant bite out of headline growth (subtracting 1.1 percentage points) as export growth (+3.0%) failed to keep up with imports (+6.3). Inventories also subtracted from growth (-0.7 percentage points) as firms added slightly less to their stocks.

It was another quarter of solid income gains, as aggregate employment compensation climbed 6.1% – its strongest gain since 2011. This was down largely to a 6% gain in wages and salaries. Household disposable income was up a solid 5.2%, leading to a slight uptick in the household savings rate, to 4.2%, from an upwardly revised rate of 4% previously.

Momentum heading into 2018 is modest. Monthly GDP was up 0.1% month-on-month in December as 13 of 20 major industries expanded. The goods-producing side of the economy pulled back slightly (-0.1%) on weakness in manufacturing (-0.7%) and construction (-0.3%). Services (+0.1%) held up, bringing its run of uninterrupted growth to 21 months as weakness in wholesale and retail trade were offset by gains in nearly all other categories.

Key Implications

Fade the headline on this one. Trade may have led fourth quarter growth to disappoint our earlier expectations, but the story today is one of a still-healthy domestic economy – final domestic demand rose a robust 3.9%, a strong performance to close what has been a strong year. Strength in investment, notably on the non-residential side was an encouraging sign, while government spending also provided a backstop to growth. One quarter is hardly a trend, but the modest slowing of consumer spending towards a more sustainable pace is to be expected in light of high household indebtedness and rising interest rates.

To be sure, headwinds are mounting. The surge in residential investment was almost certainly due to a pull-forward of activity ahead of mortgage underwriting changes. Data received so far for 2018 indicates that this sector will see a big reversal in Q1. Trade also remains a wildcard, with a plethora of near-term headwinds. On the flip side, healthy income gains, a moderately favourable investment environment (at least for domestically-focused firms), and ongoing government stimulus all suggest that growth is likely to continue, albeit at a more sustainable pace.

Turning to the Bank of Canada, the wages and salaries measure of the national accounts, which a January research note notes has the highest weight in their ‘wage-common’ measure – roared ahead in Q4. This is up 4.9% year-on-year and continues a now six-quarter run of acceleration, marking its fourth straight quarter of gains above 3%. External uncertainties, the impact of past rate hikes and changes to mortgage underwriting rules all suggest that the best approach for now is to ‘wait and see.’ Still, with Canada in the mature part of the economic cycle and inflation pressures continuing to rise, more rate hikes are likely in store.