Canada’s economy is slowing quickly as inflation, rising rates take hold

A multi-family development under construction in Vancouver on May 13.DARRYL DYCK/The Globe and Mail

The Canadian economy posted robust growth in the second quarter, but there are mounting signs of a slowdown as consumers grapple with sky-high inflation and rising interest rates.

Real gross domestic product stalled in May, which was better than the initial estimate of a 0.2-per-cent drop, Statistics Canada said in a report on Friday. The economy eked out growth of 0.1 per cent in June, according to a preliminary estimate. Thanks to stronger growth in April, Canada’s economy is on track to expand by 1.1 per cent in the second quarter, or an annualized rate of 4.6 per cent.

For financial analysts on Bay Street, the report was a mixed bag. Economic growth in the April-to-June period was stronger than the Bank of Canada’s forecast of 4 per cent. It was also markedly better than in the United States, which has posted two consecutive quarters of declining GDP, sparking a hearty debate over whether the country is mired in a recession.

On the other hand, recent months have seen sluggish growth in Canada. Consumer and business confidence is tumbling. The real estate industry has turned cold. And some high-profile companies in the tech sector – such as Shopify Inc. – are announcing layoffs.

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Stephen Brown, senior economist at Capital Economics, said he was surprised by the tepid estimate for June growth, given that hours worked that month jumped by 1.3 per cent. Moreover, he noted that Canada’s economic recovery from COVID-19 has lagged behind the US pace, and therefore Canada’s better fortunes of late are not as impressive as they seem.

“The fact that we’re already seeing a slowdown is a bit concerning,” Mr. Brown said. “We’ve been fairly bearish on the outlook for Canada, just because of the housing sector, but it does seem that we’re getting greater weakness elsewhere than was maybe anticipated.”

Despite the shift, the Bank of Canada is widely expected to continue hiking interest rates as it looks to tamp down inflation that is running near a four-decade high. The bank has raised its policy rate to 2.5 per cent from a pandemic low of 0.25 per cent in less than five months.

“The Bank of Canada is still expected to deliver a further, non-standard, rate hike at its next meeting” in September, said Andrew Grantham, a senior economist at CIBC Capital Markets, in a note to clients. “However, we expect that the impact on disposable incomes of high inflation and rising interest rates will start to show up more widely in economic data for the second half of the year, allowing the Bank of Canada to pause with rates just above 3 per cent .”

Friday’s report showed a split between the goods and services sides of the economy, the latter of which is getting a boost from consumers embracing the travel and entertainment industries.

The transportation and warehousing sector rose 1.9 per cent in May. Despite well-publicized headaches at major airports, economic output in air transportation jumped 14.1 per cent.

The hospitality sector also rose 1.9 per cent, its fourth consecutive month of expansion. Restaurant sales grew quickly this spring, in spite of sticker shock on menus.

The goods side was undoubtedly weaker. Real GDP fell 1.7 per cent in manufacturing, the first decline in eight months. Statscan said auto production was hampered by the lingering semiconductor shortage, in addition to refurbishments of some assembly plants.

Output fell 1.6 per cent in construction, the industry’s second consecutive monthly drop. Statscan noted that many of Ontario’s unionized construction workers were on strike in May, leading to delays for various projects. Residential-building construction dropped in May, but activity was 11 per cent higher than at the outset of the pandemic.

“We’re seeing a downturn in renovations and improvements, which is linked to the housing market,” Mr. Brown said. “Obviously, to the extent fewer investors are flipping homes, that means they’re going to be putting less money into improving them.”

Mr. Brown also pointed to preconstruction home sales in Toronto, which have fallen sharply. “That suggests we’ll see a downturn in housing starts over the second half of the year, just because so many developers rely on those preconstruction sales to get the initial funding.”

The outlook for Canada’s economy is murky. Recession fears are rising, although very few economists are projecting a sustained downturn. The Bank of Canada forecasts growth will slow to an annualized rate of 2 per cent in the third quarter. It also expects the economy to grow 1.8 per cent in 2023 – a hefty downgrade from 3.2 per cent in a previous forecast.

“On balance, we look for growth to cool notably in the second half to below a 1-per-cent annualized clip, a marked slowdown, albeit firmer than US trends,” Bank of Montreal chief economist Doug Porter wrote in a research note.

The country, he added, “can’t fully avoid the pull of a slowing US economy and the Bank of Canada’s aggressive rate hike campaign.”

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