Oil shock slows Canada's economy in first quarter

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The Canadian economy moved backward in the first quarter, its weakest quarter since the Great Recession, as the pervasive effects of the slump in oil prices fuelled doubts about how well Canada is weathering the oil shock – and how much more bad news is yet to come.

Statistics Canada reported Friday that the country's gross domestic product shrank by an annualized rate of 0.6 per cent in the first three months of the year, far below the fourth quarter's growth rate of 2.2 per cent. It was the worst performance since the second quarter of 2009, and only the second time since the recession ended that the economy contracted.

Economists had braced for a first quarter that was severely hampered by the effects of the plunge in the price of oil, a major contributor to Canada's economy. But most still held out hope that the economy had scratched out some growth in the quarter.

Those hopes have now been dashed – raising questions about how badly Canada has been hurt by the oil price shock, and how long it will take to overcome the damage.

"Today's data suggest the oil shock is much larger than the Bank of Canada had feared, and may be affecting other sectors of the economy, including households," Merrill Lynch economist Emanuella Enenajor said in a research note.

The result included a disappointing 0.2-per-cent month-over-month decline in GDP in March. Most economists had expected a modestly brighter March, after harsh weather in many parts of North America had weighed down activity earlier in the year. But a 2.7-per-cent plunge in the energy sector, coupled with a 0.8-per-cent decline in construction, underlined the deepening slowdown in the oil patch.

For the quarter, the mining, quarrying and oil-and-gas extraction segment contracted 2.7 per cent (more than 10 per cent annualized). But more dramatic evidence of the oil shock's impact was in business investment, as slumping cash flows prompted the usually heavy-spending energy sector to slash budgets. Gross fixed capital formation – the key measure of investment in facilities, equipment and machinery – plunged 7 per cent annualized in the quarter, its worst decline since the recession.

Gross domestic income tumbled 1.2 per cent in the quarter, or nearly 5 per cent annualized, reflecting the sharp reduction in revenue coming into the energy sector.

"The 0.6-per-cent annualized drop in real GDP understates the damage to incomes associated with diving prices for what we sell to the rest of the world," Canadian Imperial Bank of Commerce economists Avery Shenfeld and Nick Exarhos wrote in a research note. "Nominal GDP, which includes those price impacts, plunged at a 2.9-per-cent pace, capturing the weakness in oil and other commodity prices in our export basket."

Those income declines may be having ripple effects on domestic demand. Final consumption expenditures rose a thin 0.1 per cent annualized in the quarter, their weakest since the recession, while household consumption grew just 0.4 per cent, the slowest in nearly three years.

The Bank of Canada has been cautioning for months that the first-quarter economic data would be weak. However, the central bank has maintained that the impact of the oil shock appears to have been "front-loaded," meaning that it arrived earlier than anticipated and would therefore begin to fade earlier. The central bank has repeatedly said that the first quarter would suffer the worst of the damage, but the economy would start to rebound in the second quarter, and would accelerate to annualized growth north of 2.5 per cent in the second half of the year.

However, the first-quarter result was considerably worse than the central bank's estimate of zero per cent. The economy arrived at the second quarter in a deeper hole than the Bank of Canada imagined.

"We have a lot of work to do in the second quarter," said Mark Chandler, head of Canadian fixed-income and currency strategy at RBC Dominion Securities. "At very least, I don't think it's going to bounce back as quickly as [the Bank of Canada] had hoped."

"Most worryingly, things seemed to be getting worse as the first quarter went on," Paul Ashworth, chief North American economist at Capital Economics, said in a note to clients.

And economists warned that lingering effects from the oil shock may hang over the economy for months yet, as unemployment and government spending cuts in energy-heavy provinces weigh further on consumption.

Meanwhile, weak U.S. growth numbers Friday added another threat to Canada's hoped-for recovery.

The second estimate of U.S. first-quarter GDP – typically much more accurate than the preliminary estimate – was revised sharply downward, to a decline of 0.7 per cent annualized, even worse than Canada's performance. While U.S. growth is believed to have been temporarily held back by unusually harsh winter weather and West Coast port strikes, the negative reading raised questions about the anticipated strong U.S. growth this year – which the Bank of Canada and others have been counting on to fuel Canadian exports and lift the economy out of its oil doldrums.

"The bigger question is whether the U.S. bounces back from this slump," said Bank of Montreal chief economist Douglas Porter. "The jury is still out on this."