Canada suffers shock economic contraction, casting shadow over recovery

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The Canadian economy suffered an unexpected contraction in the second quarter, casting a shadow over the country’s efforts to recover from the effects of the pandemic.

Real gross domestic product fell 0.3 per cent, Statistics Canada reported Tuesday. It was an annualized drop of 1.1 per cent, and Canada’s first quarterly decline in output since the second quarter of 2020, when the first wave of COVID-19 ravaged the economy.

Exports were the biggest drag, tumbling at a 15-per-cent annualized rate. Vehicle exports were especially hard hit by supply chain disruptions, Statscan said in its report.

Throughout the world, in many different industries, key materials have been difficult to source and costs have risen rapidly during the pandemic. Freight rates have surged to record highs, and container ships now wait days to unload at ports, leading to incessant headaches for companies.

Those supply challenges are poised to continue, particularly as the Delta variant of the coronavirus spreads. As a result, Canadian businesses are bracing for continued virus-related troubles, despite the country’s enviable vaccination rate.

The GDP report startled Bay Street, where analysts had predicted the economy would grow at an annualized rate of 2.5 per cent, shaking off the effects of the third wave of the pandemic. The Bank of Canada had projected a 2-per-cent gain.

Statscan said real GDP dropped 0.4 per cent in July, erasing about half of June’s gain, according to a preliminary estimate. This also surprised analysts, who were expecting a healthy start to summer as Canadians unleashed their pent-up savings following the lifting of some pandemic restrictions.

“It was quite a bit weaker than expected,” Stephen Brown, senior Canada economist at Capital Economics, said of Tuesday’s report. “The key message here is that perhaps the recovery isn’t as strong as economists have thought.”

Analysts were caught off guard by sizable downward revisions to GDP numbers for April and May in the report, which showed the economy took a larger hit from the third wave of COVID-19 than Statscan had previously indicated.

Derek Holt, head of capital markets economics at Bank of Nova Scotia, criticized Statscan for not explaining the revisions, particularly with an election less than three weeks away, and with Canada’s economic recovery a key topic of debate on the campaign trail.

“To all of a sudden push through some very large revisions that blow everybody’s forecasts out of the water, including the Bank of Canada’s, and not even attempt an explanation, I think is an error in judgment,” he said.

“Nobody would fault them for getting better survey-based information ... for what happened to growth in the last few months. But at a minimum, explain yourselves. Otherwise, it doesn’t build confidence in the data.”

Statscan didn’t respond to a request for comment.

The housing sector, which is coming off a period of rapid gains, was a weak spot in Tuesday’s report.

Residential investment fell 12.4 per cent on an annualized basis in the second quarter. This was a result of a steep drop in costs associated with the transfer of residential homes between people. Home resale activity has cooled from record highs in major markets across the country.

Business investment was a notable highlight. It expanded at an annualized rate of 12.1 per cent, as companies ploughed money into machinery and equipment.

With many restrictions in place last quarter, Canadians stashed away plenty of cash, sending the household savings rate up to 14.2 per cent, from 13 per cent in the previous quarter. Household consumption remained steady.

That buildup of savings has fuelled expectations that heavy spending could support Canada’s economic recovery.

A potential concern, however, is that supply troubles are preventing people from making purchases, Mr. Brown said.

“If you’re looking for certain electronics, you just can’t get them at the moment,” he noted. “That is another reason why it could take longer for GDP to fully recover.”

Following Tuesday’s surprise, Bay Street started redrawing its forecasts for this year. Bank of Montreal now expects a GDP expansion of 5 per cent in 2021, down from its previous projection of 6 per cent.

The slowdown all but assures the Bank of Canada won’t announce any further tapering of its asset purchases at next week’s rate decision, Mr. Brown said, though October remains a distinct possibility. Meanwhile, the bank’s key lending rate is not expected to climb from 0.25 per cent until the second half of next year, at the earliest.

“What matters most is that we have more slack in the economy than we thought before 8:30 this morning,” Mr. Holt said on Tuesday. “That might translate into a little bit more caution, even by the Bank of Canada, when they were already inclined to talk down some of the inflation numbers that we’ve been getting.”

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