Skip to main content

Engine Specialist Jennifer Souch assembles a Camaro engine at the GM factory in Oshawa, Ont., in 2011.Frank Gunn/The Canadian Press

Canada's economy picked itself up after being knocked down at the start of the year, as household spending and exports powered the strongest quarterly economic expansion in over two years.

Gross domestic product accelerated to an annual growth rate of 3.1 per cent in the second quarter, faster than Bay Street was expecting and a big improvement on the meagre 0.9-per-cent advance posted in the first three months of the year.

The data are the last significant indicators officials at the Bank of Canada will see before they reset their policy stance next week. The second-quarter GDP figure was stronger than the 2.5-per-cent gain central bankers forecast in their most recent economic update in July. But the details of the report show Canada's economy remains wobbly, giving the central bank plenty of reasons to extend the current period of extraordinarily low borrowing costs.

Bank of Canada Governor Stephen Poloz is working on the assumption that Canada's debt-heavy households are tapped out and that future economic growth must come from exports and business investment. The former surged at an annual rate of 17.8 per cent in the second quarter as Canadian companies benefit from resurgent demand in the United States.

Business investment, however, remained lifeless. Despite coffers that are bursting with cash, company spending on non-residential structures, machinery and equipment increased at a limp annual rate of 0.9 per cent in the second quarter, a less-than-vigorous rebound from declines in the previous two quarters.

"Business investment is unmistakably disappointing," Jimmy Jean, an economist at Desjardins Capital Markets in Montreal, wrote in an advisory note to clients.

Canada's continued reliance on consumer spending and housing as primary sources of economic growth also remains a problem. Household spending advanced at an annual rate of 3.8 per cent in the second quarter, the fastest since it grew at the same pace a year earlier. And builders still sense plenty of demand for houses: Investment in residential structures surged at an annual rate of 11.9 per cent in the second quarter after declines over the winter months.

Consumers are being tempted by once-in-a-lifetime opportunities to borrow cheaply, thanks to low interest rates, and Canada's household debt is at record levels. The Bank of Canada assumes consumers' self-preservation mechanisms will kick in and that domestic demand will cool as households pull back to reduce the risk of bankruptcy and foreclosure.

The GDP report contained a suggestion that Canadians instead are reducing their nest eggs to prop up their spending habits: The savings rate dropped to 3.9 per cent from 5 per cent in the first quarter.

"We believe the underlying momentum in the economy has not changed," Charles St-Arnaud, a former Bank of Canada economist who now works at Nomura International in London, wrote in a report. "We think the Bank of Canada will remain on hold at next week's policy meeting and will remain cautious about the economy."

Mr. Poloz said in an interview last week that he sensed the economy was growing roughly in line with what he and his colleagues foresaw in July. He described export numbers only as "okay," and he said that the economy has "lots of room to grow" before it exerts upward pressure on inflation, which the central bank watches to guide its policy decisions.

Despite the question marks that hang over Canada's economic outlook, Finance Minister Joe Oliver seized on the positive headline. "Canada is on the right track," he said in a statement. Mr. Oliver reiterated his pledge to balance the federal budget in 2015 and seek to further reduce personal tax rates, saying the latest GDP report is "evidence" Prime Minister Stephen Harper's policies are working.

It's possible the second quarter will represent a turning point in the North American economy. The U.S. grew at an annual rate of 4.2 per cent in the second quarter, implying strong demand from Canada's largest trading partner. The prospect of steady sales could spur businesses to overcome their caution and boost investment. But the Bank of Canada won't shift its policy stance until it sees proof of that. Sébastien Lavoie, assistant chief economist at Laurentian Bank Securities, predicted the central bank's benchmark rate would remain at 1 per cent for a "considerable" period.