The Canadian economy contracted by 0.2% quarter/quarter annualized (q/q) in 2023 Q2. Furthermore, the flash estimate for July was essentially unchanged. Stripping out external factors, final domestic demand came in at 1% q/q, right on our expectation for positive, but still below trend growth.
Housing was once again a big drag on the economy, down 8.2% q/q. New construction and a lack of renovation activity weighed on the sector, as high interest rates continue to curb activity. While there was a bounce back in real estate transactions during the spring, this wasn’t enough to provide an offset.
Canadian consumer spending slowed to 0.2% q/q, from 4.75% q/q in Q1 (also revised lower). Spending on goods increased by 0.6% q/q, as expenditures on new trucks, vans and sport utility vehicles rose enough to offset declines in new passenger cars, furniture, and major durables for outdoor recreation. Spending on services didn’t grow at all as Canadians held back on spending abroad and going out to bars.
Trade was also a drag as imports (+1.9% q/q) rose more than exports (0.4% q/q). Imports rose on the back of “unwrought gold, silver and platinum group metals and their alloys, passenger cars and light trucks and aircraft”, while exports were slowed by declines in “crude oil and bitumen, wheat and canola”.
The incomes of Canadians also rose, as employee compensation surged 9.1% q/q. This caused the savings rate to rise to 5.1%, from 3.7% in the first quarter.
Key Implications
So much for that overheating economy. While Canada’s economy was widely expected to slow in the second quarter of 2023, today’s report came well under expectations. Various special factors contributed to this, including the multiple worker strike actions and rampant wildfires, which shut down oil & gas production in May and limited consumer activity in June. While federal government transfers in July may result in a short-term boost in the third quarter, we believe Canada has entered a stage of below trend economic growth. This should continue through the rest of this year, as the impact of high interest rates work through the economy to prevent another acceleration in demand.
When the Bank of Canada decided to raise rates in June and July, it did so largely because consumer momentum was so strong in the first quarter of 2023. But with today’s weak report and with employment growth decelerating to a 12k pace (three-month average), from 80k in the first quarter, consumer demand should continue to act as a weight on growth. This cooling off is exactly what the BoC wants to see in order to be confident that inflation will keep pushing towards the 2% target. We think it will continue, justifying our call for the BoC to remain on the sidelines for the rest of this year. Markets are taking this cue with the Canada 2-year and 10-year yields falling this morning, and down by approximately 30 basis points over the last two weeks.
