The Canadian economy grew faster than expected in the third quarter, although weakening housing investment and consumer spending suggests rising interest rates are beginning to bite and the economy is starting to sputter.
Gross domestic product increased 2.9 per cent on an annualized basis from July to September, Statistics Canada said Tuesday. That’s well ahead of the Bank of Canada’s forecast of 1.5-per-cent growth in the quarter. Preliminary data for October, however, showed the economy flatlining.
The mixed picture sets the stage for another interest rate hike by the Bank of Canada on Dec. 7. Private-sector forecasters are split on whether the central bank will move by another 50 basis points, as it did in October, or shift down to a smaller 25-basis-point rate hike. (A basis point is one-hundredth of a percentage point.)
“While headline growth was stronger than expected in Q3, it shouldn’t change the trajectory for Bank of Canada policy,” Canadian Imperial Bank of Commerce economist Andrew Grantham wrote in a note to clients. “We continue to expect a final 50bp rate hike to a peak of 4.25 per cent, before the bank moves to the sidelines in 2023 to observe how the economy is coping with these higher interest rates.”
Much of the growth in the third quarter came from higher energy and agriculture exports, as well as from companies building up inventories. Prices for crude oil and bitumen fell in the quarter, but export volumes increased significantly. Better weather also helped boost wheat production, buoying farm exports.
These gains, however, could be hard to repeat. And there are growing signs of weakness in the domestic economy.
Household spending declined 0.3 per cent in the quarter, the first drop since the second quarter of 2021. Much of this came from lower spending on goods. Spending on services continued to grow, although at a much slower pace than in the previous quarter.
Investment in housing also fell sharply, with a 15.4-per-cent annualized decline in residential investment. Renovation and housing resale activity both fell, as rising interest rates continue to push up mortgage costs.
“Consumer confidence has softened along with the pullback in housing markets, weaker financial markets, surging inflation, and higher borrowing costs. And higher interest rates will continue to gradually feed through more significantly to actual household borrowing costs in quarters ahead,” Royal Bank of Canada assistant chief economist Nathan Janzen wrote in a note to clients.
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Final domestic demand, which adds up consumption expenditures and capital investment, contracted 0.2 per cent, after a 0.6-per-cent increase in the second quarter.
This suggests that the Bank of Canada’s rate hikes are having their intended effect. The central bank has raised rates six times since March in an effort to tackle high inflation. Higher interest rates make it more expensive for households and businesses to borrow money, with the goal of reducing demand for goods and services and slowing the pace of price increases.
The annual rate of inflation remained steady at 6.9 per cent in October, which is down from a peak of 8.1 per cent in June. That is still more than three times the central bank’s 2-per-cent inflation target.
The central bank appears to be nearing a pivot point as the economy begins to slow. After a headlong dash to get interest rates up to restrictive levels, the bank is trying to maintain a balance between doing too much and doing too little. It surprised markets in October by moving only 50 basis points, instead of 75 basis points as the market expected.
“If we don’t do enough, Canadians will continue to endure the hardship of high inflation,” Bank of Canada Governor Tiff Macklem told the parliamentary finance committee last week. “If we do too much, we could slow the economy more than needed. And we know that has harmful consequences for people’s ability to service their debts, for their jobs and for their businesses.”
The Bank of Canada expects 0.5-per-cent annualized growth in the fourth quarter, and essentially zero growth through the first half of 2023. It has said there is a roughly 50-per-cent chance Canada will experience several quarters of negative growth, which is often seen as the technical definition of a recession.