Section 1: Current economic conditions

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Overview ¹ 

Second-quarter GDP decreased 0.9% in volume, its third consecutive sizeable drop. Exports fell rapidly for the third straight quarter, and this decline was reflected in sharply lower business investment (which, according to the mid-year survey of investment intentions was concentrated in mining and manufacturing). Firms also slashed inventories by over $10 billion (at annual rates) for a second straight quarter, especially auto retailers.

Some sectors of domestic demand improved in the second quarter. Consumer spending rebounded from back-to-back declines. Housing posted its first increase in over a year, reflecting buoyancy in existing home sales and renovations. Government investment outlays posted their largest quarterly gain since early 2008. Overall, final domestic demand rose in the second quarter, just as credit flows to the domestic economy (excluding government) improved after two quarters of decline.

Canada’s real GDP in the second quarter lagged the other G7 nations, after posting a relatively smaller decline in the first. Japan recorded a 0.9% gain, while Europe was stabilized by increases of 0.3% in Germany and France which offset drops of 0.5% in Italy and 0.7% in the UK. The rate of decline in the US slowed to -0.3%.

The reasons for the second-quarter slump in Canada relative to other countries appear to centre on our relatively large exposure to exports, especially to key markets in the US that remained exceptionally weak in the spring (such as autos, machinery and equipment and natural gas). As well, the Canadian dollar rose faster in the second quarter than the other G7 exchange rates, which further dampened export earnings.

However, the shortfall of growth in Canada could soon be reversed. Canada’s greater exposure to cyclically-sensitive sectors in the US could quickly become a benefit as the US auto, housing and industrial sectors all show signs of turning up over the summer. Already, there were indications that Canada’s economy began to expand over the summer. Real GDP in June eked out a small increase, even before the auto sector improved noticeably in July. These gains are consistent with the upturn in the leading index in July. Employment rebounded in August from a drop in July that followed a levelling off in the second quarter.

Labour markets

Employment rose 0.2% in August, reversing most of its dip in July. Employment has firmed since March, edging down 0.2% over the past five months versus a 2.1% drop over the previous five months. All of the drop in jobs since March was concentrated in youths, as adult employment has risen 1.6% from its trough in March. With the labour force expanding 0.3% in August, the unemployment rate edged up to 8.7%.

Private sector payrolls expanded by 0.5% in August, their first increase since last September. Finance, trade and construction led the gain. Business services remained weak, while the public sector shrank for a third straight month.

Employment growth was spread across the country, except for the prairies. Goods-handling services led the increase in Quebec, while construction buttressed employment in Ontario. Manufacturing was the major source of weakness in Alberta.

Leading indicators

The composite leading index rose 0.4% in July, after small declines in May and June were revised up to no change. The increase in July was the first advance since August 2008, just before global financial markets deteriorated significantly. Six of ten components expanded in July, the most since May 2008. Just four months earlier, the money supply was the only component that increased, when the overall index fell 1.4%, its fastest rate of decline in the current downturn.

The stock market and housing continued to post the largest gains, although the stock market leapfrogged ahead of housing with a 5.7% increase. The upturn in household spending spread from housing to other durable goods, which posted their first advance in over a year. Not all sectors of household spending were upbeat. Furniture and appliance sales continued to trend down, while personal services pulled down services employment.

The leading indicator for the United States continued to improve, rising 0.4% for the first back-to-back gain over two years. House sales and starts turned up in the last three months, while industrial output stabilized. The improvement in the US economy was not reflected in Canada’s manufacturing sector, where new orders continued to decline, falling nearly 6%. Meanwhile, the ratio of shipments to inventories continued to be restrained by falling exports, notably autos and forestry products.

Output

Real GDP edged up 0.1% in June, its first increase since last July. Services led the way, posting its largest advance since January 2008. Meanwhile, the decline in goods output slowed markedly, outside of major shutdowns in metal mining.

Almost all services contributed to growth. Real estate continued to be buoyed by the rapid recovery of home sales, while finance generally was lifted by improving financial and credit markets. Wholesale trade and transportation rebounded from slight declines in May as the volume of trade recovered. Household demand rose for retail goods as well as recreation services. Travel-related services such as accommodation and food overall were not affected by the sharp drop in visitors from the US that accompanied tighter rules to cross the border: this suggests some offset from domestic travel by Canadians, who also avoided crossing the border (despite the recent increase in the Canadian dollar, same-day auto trips fell to a record low, outside of the terrorist attacks in 2001).

There were two exceptions to the strength in services. Business services remained weak. And communications fell steadily, notably newspaper publishing as some dailies cut back publishing by one day a week. Radio and TV also saw viewership decline steadily.

Goods output fell by 0.6%, with over half of the drop coming from a 20% cut in metal mining and smelting and refining as a major producer shut down for the summer. Most other mining industries recovered slowly, led by oil and gas. Manufacturing began to level off, excluding the drop in smelting and refining. Auto assemblies were little changed at a very low level after several plants shutdown for almost all of May and June. Most capital goods industries continued to post declines of about 1%. Wood and non-metallic minerals were exceptions, recording their first gains since last fall as construction began to firm.

Household demand

Consumer spending turned up in the second quarter, as borrowing increased and disposable incomes rebounded 0.6%. Incomes were supported by lower taxes and a 6% increase in transfers from government (mostly EI benefits), which offset another drop in labour income. After jumping to 5% when the crisis unfolded late in 2008, the savings rate was stable at 4.5% so far this year.

Retail sales volume rose 0.4% in June, capping a 0.8% gain in the second quarter after three straight quarterly declines. Unlike previous increases in 2009, the advance was led by non-durable goods such as food, energy and alcohol.

Spending on big-ticket durable goods was flat, after a solid 1.7% gain in May. Auto sales fell slightly, although they picked up sharply in July. Sales of non-automotive durable goods rose 1.1%, their third straight advance. This steady improvement was driven by furniture and appliances, which began to respond to the ongoing strength in home sales.

Existing home sales rose another 2.5% in July, their sixth straight increase. Sales have risen 10% above their level before last fall’s tumble, and are close to their record set in 2007. A rebound in house prices also led more households to list their house for a second straight month.

The strength in the market for existing homes was not reflected in new homes. New home sales in July fell for the fourth month in a row. Despite weak demand, the number of unsold homes continued to decline, as builders have kept starts at historically low levels. Housing starts fell 4% in July, and so far this year are 44% below the same period in 2008.

Merchandise trade

The current account was in deficit for the third straight quarter, rising to $11.2 billion. The goods balance slipped into deficit for the first time since 1976 as exports fell steadily. The investment income deficit also grew, as interest payments rose to non-residents after they bought large amounts of Canadian bonds this year while Canadians sold-off foreign debt.

Exports rose in June for only the second time this year, although the rate of decline in the spring was markedly less than the large drop posted between October 2008 and January 2009. With imports falling steadily, the trade deficit shrank by $1 billion.

Most of the 2.3% increase in exports reflected higher prices for energy and industrial goods. Energy was led by US demand for crude oil, as natural gas exports weakened further. Gold led the gain in industrial goods.

Exports of manufactured goods continued to falter. Machinery and equipment slid another 4%, as demand for ICT goods and industrial machinery slumped. Auto exports fell largely due to a 36% drop for trucks, which felt the full impact of the permanent closing of a plant in May.

Imports dipped 1.3%, partly because of widespread price declines as the exchange rate continued to appreciate. Demand remained weakest for industrial and capital goods. Auto imports edged up in response to firming sales in Canada.

Prices

The implicit price for GDP rose 0.3% in the second quarter, after two large declines. Most notably, the terms of trade improved for the first time in a year. While export prices continued to fall, import prices fell even faster as the recovery in the exchange rate lowered the cost of imports. This was reflected in prices paid by domestic spenders, which slowed to no change in the second quarter.

Consumer prices dipped 0.3% in July, reversing the increase in June and leaving prices 0.9% below the level in July 2008. Most of the drop originated in lower energy prices, primarily gasoline (which was 28% below last summer’s record highs).

The price of durable goods returned to the downward trend posted during the winter, after firming during the second quarter. Declines were widespread among autos, furniture and recreation equipment, despite stronger demand as summer began. This suggests the recent strength in the dollar played a role. Between March and June, the price of imported consumer goods fell 10%.

Non-durable goods exerted the most upward pressure on prices. While the increase in food prices moderated further from its hikes last winter, prices accelerated for other goods such as newspapers and dental care.

Commodity prices in August resumed their recovery after a setback in July. Energy led the way, with crude oil breaching US$70 a barrel, even as natural gas plumbed 7-year lows. Metals also moved higher, with nickel and zinc setting highs for the year. These two metals are key inputs into steel production. Food prices fell, even as poor weather dampened the potential grain crop in western Canada.

Manufacturing prices fell 0.5% in July, reversing their increase in June and their third drop in four months. Most of July’s decline reflected lower oil prices, after three straight increases. A slight rise in the exchange rate also helped dampen prices for exported goods.

Financial markets

The second-quarter financial flows showed improved credit availability and demand in most major domestic sectors. Household borrowing picked up, after slowing over the previous two quarters, as rising house sales raised mortgage demand. Corporations raised more money, as they stepped up bond issues while retiring short-term debt. Governments issued more debt, with the exception of the federal government one-time program related to insuring mortgages in the first quarter. Non-residents supplied increasing amounts of funds to meet demand in Canada.

In the second quarter, net lending in some sectors returned to their trend before last fall’s crisis. Households began to borrow more ($29.4 billion) after lowering debt growth sharply from $53.5 billion to $20.7 billion (at annual rates) over the previous two quarters. And net lending by corporations rebounded to a record $70 billion, as firms slashed spending on investment and inventories much faster than profits fell. In past recessions, it took firms a year or two to return to even small surpluses. Conversely, the trend towards large government and external borrowing continued, rising to $79.3 billion and $42.5 billion respectively, mostly due to sharply lower incomes.

The stock market edged up 1% in August, continuing the upward trend that began in March. Most sectors posted modest gains, led by mining which added to its large advance over the summer.

Regional economies

In Quebec, household demand remained the strongest in Canada. Housing starts in July rose 23% to 40,000 units, their highest level of the year, and exceeding starts in Ontario for the first time since January 1992 (as recently as February 2003, starts in Ontario were over 100,000 larger than in Quebec). Retail sales in June rose 1.8% after a 1.3% gain in May. Manufacturing sales rebounded 6% in June, the largest regional gain in Canada as aerospace recovered most of its drop in May.

BC continued to recover from a weak first quarter. Retail sales in June posted a third straight increase, and matched Quebec’s 0.9% quarterly advance. Manufacturing sales rebounded 2%, with wood rising to its highest level of the year as the US housing market firmed. Housing starts in BC dipped in July, but remained above their lows set during the spring.

On the prairies, retail sales were the strongest sector in June, accelerating to a 1.7% gain. However, the quarterly increase of 0.2% was the slowest in Canada. Manufacturing sales dipped in June, and their quarterly decline of 6% was the largest of any region. Housing starts dipped in July, but remain well ahead of their spring lows after a 60% hike in June.

Demand in Ontario remained sluggish across the board. Housing starts slipped 15% in July to 37,000 units, less than half their level last autumn. Retail sales were flat in June, the only region that sales did not expand, despite a spike in alcohol sales ahead of a possible strike at liquor stores. Manufacturing sales fell marginally, as many auto plants remained idle until month-end. However, the revival of auto output over the summer will be of most benefit to Ontario.

International travel flows in and out of Canada fell sharply in June, when the US mandated the presentation of passports to cross its border with Canada. The drop in international travel flows in June disproportionately affected Ontario. However, the drop in US travellers entering Ontario was almost exactly offset by a reduced outflow visiting the US, leaving net travel flows virtually unchanged.

International economies

In the United States, the housing and auto markets continued to improve, helping to boost industrial production. Existing home sales jumped 7% in July, their fourth straight gain leading to the first year-over-year increase since 2005. Prices also firmed. Housing starts dipped 1%, but only because June’s level was revised up. Starts of single homes posted a fifth consecutive modest gain, partly reflecting steadily-rising new home sales since March.

Unit auto sales jumped 16% to an annual rate of 11.2 million units in July. The governments ‘cash for clunkers’ plan helped some models, but demand improved across the board. Overall retail sales dipped 0.1% after gains in May and June, as non-auto demand fell 0.6%.

Industrial production rose 0.5% in July, led by a 20% rebound for motor vehicles. Other manufacturers boosted output 0.2%, the first increase since last October. Cool weather lowered utility output by 2.4%.

International trade flows improved in both directions for the first time since June 2008. Exports rose 2%, after a 0.6% gain in May. Imports rebounded 2.3%, boosted by more autos and higher oil prices. Import prices receded in July, notably for natural gas.

In the euro area, real GDP dipped 0.1% in the second quarter, after declines of 2.5% in the first and 1.8% in the fourth. France and Germany led the turnaround with gains of 0.3%, as consumer spending responded to government subsidies of car purchases and exports firmed. However, Italy and Britain continued to contract by 0.5% and 0.7%, although much less than in the previous two quarters.

June industrial production in the euro zone gave back its 0.6% gain in May. Output of durable consumer goods remained very weak, but non-durable consumer and capital goods firmed over the past two months. Germany held on to its 5% gain in May as orders continued to improve, especially capital goods for export. The upturn was less pronounced in France, while Italy and Britain posted modest declines.

Trade with the euro zone stabilized in June, after the rate of decline slowed during the spring. Exports dipped 0.1% while imports were flat. German exports jumped 7%, the most in nearly three years.

Unemployment in July edged up from 9.4% to 9.5%, as an increase in France offset a levelling off in Germany. Unemployment in Europe was up 2.0% points in the past year, compared with a 3.6 point increase in the US.

In Japan, real GDP rose 0.9% in the second quarter, its first increase since early 2008 although its year-over-year decline of 6.4% remained the sharpest in the G7. Exports rose 6% in the second quarter, while public investment grew by 8%. Jobs remained scarce, however, and unemployment hit a postwar high of 5.7% in July, up from 5.4% in June and 4.0% a year-earlier. Industrial production rose 1.9% in July, its fifth straight gain, led by autos and electronic goods.

Industrial output in China expanded 10.8% from July 2008. Investment growth eased slightly to 33%, partly as government ordered a slowdown in bank loan growth. Exports and imports remained 23% and 15% below a year-earlier.

Real GDP in Russia slowed to a 0.5% decline in the second quarter, leaving the loss in the past year at 11%.

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