This is the only time you will see the word “recession” in this column—even though its subject is the release Monday of a government report that showed Canada’s gross domestic product contracted for two consecutive quarters through June. The term is loaded and its meaning is disputed. The word serves no purpose in a discussion about what Statistics Canada’s second-quarter report tells us about the real state of the country’s economy, and how the central bank may respond.
Let’s start with the latter. National Bank’s economists think the Bank of Canada will cut its benchmark interest rate again next week. They probably aren’t alone. Oil prices are much lower than Governor Stephen Poloz thought they would be when policy makers released their latest forecasts in July. Given the collapse of commodity markets was the trigger for the shock interest-rate cut in January, it is reasonable to speculate that continued weakness could prompt the central bank to lower borrowing costs a third time in 2015.
However, the broader economic story of the first half unfolded roughly as the Bank of Canada said it would. Its forecasters are now officially on a roll. They were the first to see that the plunge in crude prices last year heralded serious trouble—hence the January interest-rate cut. In July, they predicted GDP would contract at an annual rate of 0.5% in the second quarter and 0.8% in the first three months of the year. Those were the figures that StatsCan released Tuesday. That suggests the central bank will leave the borrowing costs unchanged on Sept. 9, especially since the U.S. economy expanded at an annual rate of 3.7% in the second quarter. When America’s GDP expands, Canadian exports tend to follow.
Trade actually contributed to Canada’s economy in the second quarter, as international shipments gained marginally and imports declined. (Exports add to GDP because the money to pay for them enters the country, while imports subtract from output for the opposite reason.) The biggest drag on the economy was business investment, which decreased for the second consecutive quarter. Spending on mineral exploration plunged more than 33%.
Inventories also dwindled, as companies added about $7.1-billion to stockpiles compared with $12.1-billion in the first quarter. That could be a positive sign for the future, however. If demand picks up as expected, executives will have to replenish inventories, a positive for GDP. “The fall in inventories suggests some of the weakness could be temporary and indicates that this is unlikely to be repeated” in the third quarter, said Charles St-Arnaud, an economist at Nomura, a bank.
But let’s call an inventory-led rebound in the third quarter a “technical expansion.” The correct description for Canada’s economy is stagnation. The economy was saved from a worse fate in the first half by consumers. Despite carrying record levels of debt, households once again responded to the price signal sent to them by their central bank and went shopping. Consumption jumped 0.6% in the second quarter, following a gain of 0.1% in the first quarter.
This can’t continue. One of the reasons the U.S. economy took so long to recover from the financial crisis was shocked households made paying debt a priority over more credit. There is every reason to think Canada’s consumers will behave similarly. New housing construction declined 4.1% in the second quarter, indicating the strength in real-estate is reflected in prices for existing homes and commissions. Housing no longer is adding meaningfully to the real economy.
The Bank of Canada is waiting on exports, but there is good reason to think trade no longer is the answer it used to be. So who is going to want to invest when the international market is weak and consumers at home are tapped out? It’s the question any voter concerned about the state of the economy should put to every politician who comes to his or her door.
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