The Canadian economy's disappointing step backward in November has strengthened the case for the Bank of Canada to cut interest rates further to stanch the bleeding.
Statistics Canada reported Friday that gross domestic product shrank by a seasonally adjusted 0.2 per cent in the month versus October, the weakest performance in nearly a year. Year-over-year growth stood at 1.9 per cent, the slowest since last March, and down significantly from October's 2.3 per cent.
The surprise economic contraction underlined the mounting risks of a stalling of Canada's fragile economic recovery, which was the Bank of Canada's chief concern last week when it announced an unexpected cut in its key interest rate, to 0.75 per cent from 1 per cent. The disturbing data dealt another body blow to the Canadian dollar, sending it down more than a full penny to 78.22 cents (U.S.) immediately following the release, as traders upped their bets that the central bank will have to cut rates further to prop up the faltering economy.
Economists said the November disappointment puts the 2014 fourth quarter on pace for a tepid 2-per-cent annualized growth rate, making the Bank of Canada's latest estimate of 2.5 per cent, issued just last week, already look outdated. But perhaps more troubling was the source of the weakness in the November numbers: Oil wasn't the biggest problem.
The ill effects of plunging oil prices on the energy sector in November were fairly muted. Oil and gas extraction retreated 0.7 per cent in the month, at a time when the average price for crude's West Texas Intermediate benchmark averaged almost $76 (U.S.) a barrel, $30 higher than today.
The bigger source of weakness was the manufacturing sector – which is supposed to benefit from oil's weakness, as cheap fuel gives an added boost to the economy in the key U.S. export market (the world's biggest energy consumer), while the declining loonie delivers a competitive edge to Canada's non-energy exports. Yet output from Canadian factories slowed by 1.9 per cent in the month, wiping out their healthy gains in September and October.
"Even outside of energy, underlying economic growth was discouragingly soft," said Merrill Lynch economist Emanuella Enenajor.
While most experts believe the manufacturing sector will bounce back as the oil-related effects take greater hold, the discouraging November weakness presents the possibility that the non-oil economy isn't on as solid ground as many observers, including the Bank of Canada, had previously thought.
"The lack of momentum in manufacturing and non-energy exports suggests downside risk to the growth outlook," said Charles St-Arnaud, senior economist at Nomura Securities in London and a former Bank of Canada economist. "We continue to believe that the BoC will cut rates again in the coming months."
The central bank's next rate decision is March 4, less than five weeks away. That's not a lot of time for the effects of last week's rate cut – and the resulting further depreciation of the Canadian dollar – to play out in the broader economy. There's a feeling that the central bank might want more time to assess the impact of its first rate cut before committing to a second one.
The surprise nature of last week's rate cut has ramped up the uncertainty surrounding the central bank's policy path, and as a result, any additional cutting would call for some detailed explanation from Bank of Canada Governor Stephen Poloz, to keep financial markets up to speed with the bank's thinking. For that reason, the bank may prefer to wait until its April 15 rate decision, when its scheduled announcement will be accompanied by a Monetary Policy Report and a news conference with Mr. Poloz, rather than just the usual one-page policy statement that will accompany the March decision.
But given the sour November numbers and the prospect of things getting worse before they get better as the impact of the oil shock deepens, a growing number of economists feel the situation warrants quick action – the central bank should cut again at its next available policy-setting opportunity.
"The contraction in November increases the likelihood that the next move will be in March," Mr. St-Arnaud said.