Canada is in a technical recession, but there is light at the end of the tunnel.
The inevitable was confirmed when Statistics Canada announced on Sept. 1 that Canadian Q2 real GDP fell 0.5 percent, marking two straight quarters of falling GDP. The first quarter GDP’s decline was revised lower to -0.8 percent from -0.6 percent. Overall, the extent of the decline is not as bad as economists’ consensus forecasts.
The other good news is June’s GDP marked the first month of positive growth of 2015, rising by 0.5 percent. This bodes well for the rebound in Q3 GDP that policymakers expect.
It’s unlikely the U.S.’s National Bureau of Economic Research would consider Canada to be in recession since it looks at a wider range of variables, like job growth, in addition to GDP. The NBER definition includes the phrase, “a significant decline in business activity,” which only applies to the oil and gas sector in Canada. This sector makes up 9 percent of GDP in Canada, according the BoC’s July Monetary Policy Report.
“The lack of a net drop in employment over the same period meant that this was not yet an outright recession,” said CIBC’s Avery Shenfeld in a Sept. 1 note.
But rather than worrying about definitions and a few tenths of a percentage point, the bottom line is the economy, in aggregate, is not growing and is skewed by the sharp decline in the energy sector.
Breaking it Down
The culprit is business investment in the oil and gas sector, which was singled out when the BoC cut rates by 0.25 percent in July. The spending cut by companies in the oil patch was initially put at about 30 percent at the start of the year, but was revised to being closer to 40 percent by the Bank in July. Statistics Canada reported in Q2 that business fixed investment fell 12.0 percent after a fall of 17.7 percent in Q1.
This factor should remain a drag on GDP, especially as oil prices have fallen since the end of June. So July and August’s monthly GDP figures could be impacted, although other sectors of the economy are picking up.
“The investment slump is far from over considering that oil prices remain low and the sinking loonie makes it more expensive to import machinery and equipment,” said National Bank senior economist Krishen Rangasamy in a Sept. 1 note. Despite talk of a recession for at least a couple of months now, Canadians haven’t cut back on spending. Consumer spending rose 2.3 percent in Q2 after rising only 0.5 percent in Q1.
The household saving rate decreased as a result of the spending increase and drop in disposable income, but CIBC points out this is a typically a sign of household optimism.
So perhaps the threat of the self-fulfilling prophecy whereby if people believe the economy is in recession, they cut back on spending isn’t happening.
Critical to help Canada get out of the doldrums is for the U.S. economy to pick up—and it did in a big way, growing by 3.7 percent in Q2.
The Bank of Canada’s interest rate announcement on Sept. 9 should discuss how the forecasted economic rebound of Q3 is on track. The BoC had projected a 0.5 percent decline in Q2 real GDP in its July monetary policy report; it projects a 1.5 percent rise in real GDP in Q3. The odds of another rate cut are likely lower.
“Indications of a likely return to positive GDP growth in the current quarter reduces the probability for any further easing by the Bank of Canada,” said RBC in Sept. 1 note.
According to RBC, the BoC is expected to keep the overnight rate target at 0.50 percent into 2016 as long as the economy evolves according to its current forecast, which projects growth picking up later this year and in 2016.
Follow Rahul on Twitter @RV_ETBiz