MNI: Canada's Economy Shrank in Q3 While Q2 Revised To A Gain

Canada's GDP continues to evade back-to-back contractions investors have predicted for about a year now, shrinking in Q3 while the Q2 revision scrubbed away the original estimate output shrank and a flash reading showed Q4 started off with an October expansion. 

Output shrank at a 1.1% annualized pace in the third quarter, well short of the central bank's estimate for a 0.8% expansion and the economist consensus for a 0.2% increase. Statistics Canada's report Thursday revised second-quarter GDP to a 1.4% gain from the original 0.2% decline, with the improvement coming from exports and business investment.

While some economists may persist with bets on a recession the monthly GDP figures suggest another growth rebound in the fourth quarter. Output grew 0.1% in September, beating the consensus for no change, and some economists consider the last month of a quarter a signal of momentum being handed off into the next period. The flash estimate for October was even stronger with a 0.2% gain that was the biggest since May, led by natural resources, retail and construction. 

The third-quarter setback was led by tumbling energy exports and companies slowing inventory accumulation, while housing continued to show resilience in the face of the Bank of Canada's 10 interest-rate hikes. The report aligns with Governor Tiff Macklem's view growth has downshifted and bouncing around a flat line, a phase he says is needed to bring overheated demand back in line with supply. Macklem says he's still judging whether policy is restrictive enough but his other comments about soft growth and slowing inflation have economists predicting a third straight rate interest-rate hold next Wednesday at 5%, the highest since 2001. 

Exports fell at a 5.1% annualized pace in the third quarter, reversing a similar gain in the second quarter that came at a time of rising crude oil prices, and business inventory accumulation was the slowest in two years. Consumer spending was little changed for a second quarter, but Statistics Canada also said housing investment gained for the first time in six quarters. Government expenditures also climbed at a 7.3% annualized pace. 

What remains unclear as the economy fluctuates is how soon that brings inflation back to the Bank's 2% target and whether elevated price expectations will become entrenched with CPI remaining about 3% some two years after prices began surging to a peak around 8% in the pandemic rebuild. The GDP report's implicit price index rose 1.8% following a second-quarter gain of 0.4% and wages were up 1.7%.

The Bank still cautions it could hike rates if it appears inflation is getting stuck above target and the path back to 2% will take until sometime in 2025. Macklem has said he also wants to avoid overdoing restrictive policy and the path to re-balancing the economy with a soft landing is quite narrow. While the report continues a pattern of the economy showing some resilience, the baseline for upside surprises has been middling growth rather gains of 2% to 3% recorded in more normal times.

Other evidence of a fading economy has emerged in recent weeks with unemployment rising about half a percentage point from a record low. Households are also more worried now, with more than half of respondents seeing a recession coming according to the latest quarterly BOC survey. Macklem recently told lawmakers his biggest concern is getting inflation back to target and he rejects the idea Canada is moving into stagflation.

Judging the tightness of Canada’s economy is complicated with the biggest influx of immigrants in decades boosting labor supply and creating more demand, especially in a stretched housing market. Bank officials said recent economic trends can’t entirely be explained by population growth.