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Canada economy slows sharply, supporting rate pause

The Canadian economy is off to a weak start in the second half of this year after unexpectedly contracting in the second quarter, cementing the case for the Bank of Canada to hold rates steady next week.

Preliminary data suggest gross domestic product was flat in July, as increases in the public, finance and professional sectors were offset by decreases in manufacturing, transportation and construction industries, Statistics Canada reported Friday in Ottawa.

That followed a 0.2 per cent contraction in the previous month, matching a median estimate in a Bloomberg survey of economists, and a downwardly revised 0.2 per cent expansion in May.

Overall, the economy in the second quarter shrank at a 0.2 per cent annualized pace, far weaker than both a consensus estimate of 1.2 per cent and the Bank of Canada’s forecast of 1.5 per cent. That’s a deceleration from a downwardly revised 2.6 per cent pace in the first three months of 2023.

The numbers suggest the central bank’s rate increases are slowing the economy by more than expected. Canada may already be in the middle of a technical recession, if output shrinks again in the third quarter.

The report paints a clearer picture of an economy that’s gearing down rapidly under the weight of 475 basis points of interest-rate increases, and will likely be enough to convince the Bank of Canada to hold rates steady next Wednesday.

The second-quarter slowdown was due to continued declines in housing investment, smaller inventory accumulation, as well as slower international exports and household spending.

Governor Tiff Macklem and his officials forecast economic growth to moderate to an average of about one per cent through the second half of this year and the first half of 2024. They expect higher interest rates to weigh on household spending and business investment, and weak foreign demand to restrain export growth.

Friday’s report supports that projection and suggests Canada’s economy has entered a softer patch. Growth in consumption spending is expected to slow over the second half of this year, as demand for rate-sensitive goods and services weakens and more households renew their mortgages at higher rates.

The unexpected strength of household spending and increase in exports earlier this year lifted economic activity and the labor market, and prompted the Bank of Canada to abandon its pause and raise borrowing costs in June and July to a 22-year high of five per cent. Policymakers then viewed monetary policy as insufficiently restrictive and said greater excess demand were sustaining underlying price pressures.

Second-quarter data suggest rates may already be high enough to slow down the economy and rein in spending by heavily indebted Canadian households.

Growth in real household spending slowed to 0.2 per cent in the second quarter, the weakest pace in two years, from a downwardly revised 4.7 per cent in the first quarter. But while aggregate household expenditures edged up slightly, spending per capita actually fell and had declined three in the last four quarters, suggesting rapid population growth may mask some of the weakness in the economy.

Services spending slightly contracted in the second quarter.

Rising wages and disposable income also weren’t enough to buoy spending. Compensation of employees rose 9.1 per cent on an annualized basis, mainly due to higher average wages. Those gains also led to an increase of 10.7 per cent in household disposable income, a reversal from the decline in the first quarter.

Growing drought and wildfires in many regions across Canada contributed to contractions in crop production, oil and gas extraction, mining, and activities in recreational vehicle parks and camps.

In June, both services and goods-producing industries contracted, with wholesale, retail and construction sectors seeing some of the largest declines.

Source: BNN Bloomberg