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The Canadian economy rebounded strongly in the third quarter as consumers unleashed a torrent of savings in hard-hit service industries, though a new variant of COVID-19 threatens to quell momentum.

Real gross domestic product rose 1.3 per cent in the third quarter, or a 5.4-per-cent annual rate, Statistics Canada said Tuesday. While that handily beat expectations on Bay Street, the second quarter was revised to an annualized contraction of 3.2 per cent from 1.1 per cent.

The fourth quarter got off to a promising start. Real GDP jumped 0.8 per cent in October, according to a flash estimate, accelerating from a 0.1-per-cent gain in September. Activity ramped up in manufacturing, which has been slammed by a global shortage of computer chips.

But the outlook is rife with uncertainty. Flooding and mudslides in British Columbia have damaged critical infrastructure and exacerbated supply chain disruptions. The new Omicron variant is a big concern, particularly if it proves more transmissible or resistant to vaccines – details of which won’t be known for several days. Concerns over Omicron have already rattled markets, and many countries, including Canada, have tightened their borders.

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Before the emergence of Omicron, Europe and parts of the United States were already seized by another wave of coronavirus infections, prompting some countries (such as the Netherlands and Belgium) to tighten public-health measures. Thus far, Canada has avoided a steep uptick in cases, a credit to the country’s relatively high vaccination rate, said Stephen Brown, senior Canada economist at Capital Economics.

“Obviously, that high vaccination rate in Canada is meaningless if there is a [variant] that is vaccine-resistant,” he cautioned. “That’s the thing to watch.”

Consumer spending drove most of the economic growth last quarter. Household expenditures rose 4.2 per cent, or almost 18 per cent in annualized terms. Blowout gains were widespread in service industries that reopened in the summer, including recreation and culture (26.1 per cent), food and accommodation (29 per cent), personal grooming (35.8 per cent) and air travel (156 per cent).

“We get waves of economic activity that coincide with waves in the other direction for COVID,” said Avery Shenfeld, chief economist at CIBC Capital Markets. “There’s a lot of money in the bank to spend” when it’s safe to do so, he added.

Broadly speaking, Tuesday’s report suggests Canadian households are in good financial shape. Compensation of employees rose 2.9 per cent in the third quarter, the largest increase since 2000, excluding a large uptick last year as the country emerged from the first wave of COVID-19. Statscan noted that almost half of the overall increase in wages was seen in the hospitality industry, which includes restaurants and hotels.

The household savings rate fell to 11 per cent from 14 per cent in the second quarter. Still, that was much higher than an average of 3.4 per cent from 2010 to 2019, and households are sitting on hundreds of billions of dollars in excess cash. (Saving rates tend to be greater in higher income brackets.)

Despite income gains and robust hiring of late, government transfers to households remain elevated, compared to norms before the crisis. Those payments are poised to drop given the bulk of federal financial supports for individuals and businesses expired in late October.

“The main point is that households are well-prepared to deal with potential challenges ahead,” Doug Porter, chief economist at Bank of Montreal, wrote in a note to clients.

Following a slump in the second quarter, exports jumped 1.9 per cent in the third quarter, driven higher by crude oil shipments. Imports fell 0.6 per cent, while residential and business investments also cooled.

Consumer spending on durable goods fell 1.4 per cent in the third quarter, despite the ample cash on hand. “Higher prices, resulting partly from supply chain disruptions, constrained demand and spending,” Statscan said.

In nominal terms (before accounting for inflation), the economic expansion is on a tear. Bank of Montreal projects nominal GDP will jump by more than 12 per cent this year, delivering a “huge boost to government revenues, incomes and earnings,” Mr. Porter said. That would be the largest gain in nominal GDP since the early 1980s.

However, annual inflation is running at an 18-year high in Canada, while some countries are dealing with their highest inflation rates in 30-plus years, owing partly to rising energy costs and supply related troubles.

U.S. Federal Reserve chair Jerome Powell warned this week that the Omicron variant could worsen supply issues that are driving up prices. “The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation,” Mr. Powell said in written testimony ahead of an appearance before the U.S. Senate banking committee on Tuesday.

The Bank of Canada has signalled that it could start raising its key interest rate – now at a record low of 0.25 per cent – as soon as April, 2022.

“It’s a mixed picture for the Bank of Canada,” Mr. Brown said. While consumption should continue to grow rapidly, he also said there are “bubbling financial risks” from a massive rise in consumer debt over the pandemic.

“The downside risks to the outlook are quite concerning if we had something like an interest-rate shock.”

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