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Economy Lab

Flaherty is right in being a bit worried Add to ...



Coming a day after Finance Minister Jim Flaherty conceded he’s worried about another global downturn, a report this morning from Statistics Canada paints a deceptively rosy picture of the domestic economy.

Sure, Canada’s economy grew at the fastest pace in a year between January and March, as a solid three months for manufacturers and a further climb in business investment overshadowed the predictable drop in consumer spending now that households are tapped out and struggling to pay down debt and fund energy bills.



Business investment gained for a fifth consecutive three-month period, as companies continue to take advantage of the strong Canadian dollar to buy machinery and equipment overseas, and are also re-directing their fatter profits to invest in plants. Import growth outpaced export growth during the quarter, meaning trade was a net drag on gross domestic product. Sales abroad increased at a 1.6-per cent annualized pace, though -- not stellar, but not exactly alarm-bell territory.



In other words, business investment and even exports -- the two main drivers of growth now that government stimulus is running out and households are scaling back their purchasing -- had a fine quarter. And a good thing, too, since consumer spending was essentially flat, the worst showing for that category in two years.



All told, the 3.9-per cent annualized pace of growth in the first quarter was just shy of economists’ expectations, including the 4.2-per-cent estimate in the Bank of Canada’s most recent forecasts, and was more than twice the pace of expansion in the U.S. economy during the same period.



Seems like good enough news, but here’s the rub.



Much of the growth came from a sharp rebound in auto production at the beginning of the year, BMO’s Douglas Porter notes, which yielded misleadingly solid gains both for exports and inventories. Also, higher inventories -- which rose by a stunning $10.5-billion in the quarter, after a $185-million gain in the last quarter of 2010 -- could be as much a function of weaker-than-expected retail sales in the first few months of the year as a sign that companies are optimistic about future demand, Stephen Gordon of Laval University suggested in a Tweet after the report was released.



And the overall slowdown in consumer spending, while not enough to keep the personal savings rate from ticking down a couple of notches, probably means the rebound in housing investment during the quarter won’t be sustained.



Plus, even with a better-than-expected monthly reading of 0.3-per cent growth in March, which suggests decent momentum heading into the second quarter, the reality is the massive supply-chain disruptions from the Japanese earthquake are already wreaking havoc on North American auto production. Derek Holt of Scotia Capital pointed out in a research note last week that Canadian auto production probably fell by 25 per cent in April from the previous month, and part of that is because Ontario is particularly vulnerable to events in Japan, having attracted Honda and Toyota assembly plants as the top U.S. auto makers were losing customers.



So the second quarter will be nowhere near as strong as the first, with the annualized pace of growth projected to come in at 2 per cent or even slower. That’s why Monday’s report, while encouraging at first glance, will have precious little impact on the Bank of Canada, which will very likely keep interest rates on hold tomorrow and possibly until late this year as growth settles into an underwhelming average pace of between 2 and 2.5 per cent.

Expectations that rates would climb started to diminish a couple of weeks ago after Bank of Canada Governor Mark Carney indicated to an audience in Ottawa that policy makers are increasingly worried about the impact that soaring commodity prices are having on U.S. demand for other exports, at a time when the currency and competitiveness issues are already holding back Canadian companies' fortunes.

Already, export growth in the first quarter was slower than the 2.1-per-cent annual pace between October and December of last year.

Policy makers have noted that Canada is not benefiting from the current commodity boom in the same way that it did earlier this decade - when the oil patch reaped the rewards of Chinese demand at the same time that the U.S. economy was far stronger than it is now and consumers there kept on buying Canadian goods. This time around, Americans are certainly buying our energy, but spending on anything but necessities is becoming an unaffordable luxury for more and more consumers south of the border as gasoline costs soar.

Then there's Europe's worsening debt crisis, the possibility that some of the world's biggest emerging-market economies will overheat, the coming effects of deficit-cutting on this side of the border, and the eventual belt-tightening in the United States that will further weaken the recovery of Canada's No. 1 customer.

All of which is disconcerting for an economy in need of sustained business investment and robust export sales now that consumers have left the building.

If I were Mr. Flaherty, I’d be at least a little worried too.

Follow on Twitter: @jeremytorobin

 

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