Canada’s economy rebounds but momentum fears persist

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Canada's economy staged a dramatic turnaround in the third quarter, but a slowdown in September raises questions about the economy's sputtering momentum entering the final months of the year and into 2016.

Statistics Canada reported that real gross domestic product rose at a 2.3 per cent annualized rate in the third quarter, the fastest growth pace in a year. That was a solid rebound from the contractions of 0.7 per cent and 0.3 per cent, respectively, in the first and second quarters of this year, when the economy was battered by the impact of the deep decline in oil prices. (GDP for both the first and second quarters was revised up slightly in the third-quarter report.)

The third-quarter upturn was due almost entirely to a surge in exports, up 9.4 per cent annualized in the quarter, helped by an accelerating U.S. economy and the weak Canadian dollar. But total domestic demand was flat and business capital investment continued to slump, reflecting the evaporation of spending in the energy sector.

And the economy's momentum faded badly as the quarter wrapped up, with manufacturing, wholesale and retail sales fizzling in September. Statscan reported that the economy shrank 0.5 per cent month over month, the worst monthly result since the recession.

"Canada's third quarter came in like a lion and went out like a lamb, hinting that growth will again be flagging in the final trimester of the year," said Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, in a research note.

Some economists suggested that the sputtering momentum, coupled with renewed weakness in oil prices, could leave the economy on a growth pace of only about 1 per cent in the fourth quarter.

And the continuing weakness in the energy sector, which continues to suck the life out of business investment, suggests that Canada may be headed for a relatively modest 2016, despite a strengthening U.S. economy and a depleted currency that should lift non-energy exports.

That could pose some difficult questions in Ottawa, where the Bank of Canada prepares for its latest interest-rate decision Wednesday, while the new Liberal government grapples with drawing up its first budget over the next few months amid concerns of widening deficits.

The central bank already cut interest rates twice this year to stimulate the floundering economy. It is unlikely to cut rates again in Wednesday's decision, given that third-quarter growth was close to its most recent estimate of 2.5 per cent. But some economists suggest that a sluggish fourth quarter could put another rate cut on the table for early in 2016.

Parliamentary Budget Officer (PBO) Jean-Denis Fréchette, an independent watchdog of federal government finances, issued a fiscal-outlook report Tuesday that was actually more optimistic than the government on the near-term budget balance, forecasting a small surplus of $1.2-billion in the current 2015-16 fiscal year, versus the government's projection of a $3-billion deficit. (Neither projection includes any of the spending promises contained in the new Liberal government's election platform.)

However, the PBO opined that "the government's outlook for the economy and federal budget over the medium term is optimistic." Both the PBO and the government peg real GDP growth at about 2 per cent in 2016, based on the average of private-sector forecasts, but the PBO is concerned that government economic-growth and revenue forecasts for 2018 onward are too rosy.

The Liberals campaigned on an infrastructure spending plan that could help stimulate economic growth, both in the short term and in the longer term. But its plans, once they are announced, will certainly widen the projected budget deficits.

Canada's weak September GDP contained a big asterisk: Much of the decline stemmed from weak oil and gas output, and much of that was due to a late-August fire that halted most of the production at the huge Syncrude oil sands facility for the entire month.

"The energy sector alone accounting for 0.4 percentage points of the monthly drop in GDP," noted Bank of Montreal chief economist Douglas Porter in a research report. Syncrude resumed normal output in early October, suggesting that output in the sector has bounced back already.

"However, there is no denying the fact that the rest of the economy did still report a small 0.1-per-cent dip in activity in [September]," Mr. Porter said. "The Canadian economy is still struggling to grow consistently at this stage of the cycle."

"The economy is still overly dependent on housing investment and household borrowing as sources of growth," said David Madani, Canada economist for Capital Economics, in a research report. He pointed out that household consumption and residential investment accounted for a whopping 63 per cent of gross domestic product in the third quarter, the highest in 35 years of data. "Business investment is tumbling and will likely fall further in response to the worsening oil price slump."

"We still think that more policy stimulus will be needed eventually, both from monetary and fiscal policy makers," he said.

Meanwhile, the strength of the U.S. economic recovery also came into question Friday. The Institute for Supply Management's monthly manufacturing index came in below its midpoint of 50 for November, indicating that U.S. factory activity is contracting.

"Headwinds such as a strong U.S. dollar and a slowdown in the energy sector … will likely continue to weigh on manufacturing, preventing any significant acceleration in growth," said Royal Bank of Canada economist Josh Nye in a report. "However, strong growth in many other sectors of the economy should keep [U.S.] GDP growth at an above-trend pace heading into 2016."