11-010-XIB
Canadian Economic Observer
March 2006

Summary Table - Key Indicators

Overview*

Real GDP increased 0.6% in the fourth quarter, keeping year-over-year growth steady at near 3%. Final domestic demand continued to drive output, partly fuelled by earnings from higher export volumes and rising prices. This is reflected in the stronger gain in “command” GDP (which adjusts for the terms of trade) than conventional GDP. Over the past three years, domestic spending has followed command GDP in outstripping GDP growth, a reflection of how the money gained from trade is being spent in Canada.

Business investment rose 3%, matching its gain in the third quarter and consolidating its place as the most dynamic sector of the economy. Investment has risen 10.7% in the past year, its largest gain since early 1998. While machinery and equipment has consistently grown about 10% over the past two years, the most striking turnaround has been in non-residential structures. They have risen 10.6% in the past four quarters, a strong recovery from declines as recently as the previous year. This upswing was evident in both engineering (driven by the energy sector) and building.

Firms project another 9% gain in business investment in 2006, according to the annual survey of investment intentions, after back-to-back gains averaging almost 8%. The increase in investment intentions was widespread: only one of the 17 major industry groups plans to lower spending (arts and recreation).

Not surprisingly, the energy sector spearheaded the advance with a projected increase of 11%, its fourth straight year of double-digit growth. The sources of growth, however, changed from last year, when oil and gas led the way (especially a 55% hike in the oilsands). Instead, oil and gas forecast only a 7% increase this year, which may partly reflect growing shortages of labour and materials. Instead, energy investment has shifted to natural gas distribution and pipelines needed to carry the output from new projects coming on-line. As well, utilities plan a 28% jump in spending as companies in a number of provinces invest more in electric power generation.

Transportation of all types saw investment plans rise, with solid gains in air, rail and water as well as public infrastructure needed to support growing trade (especially on the west coast). Retailing was next, led by new buildings erected by general merchandisers.

Most other industries plan modest increases of less than 10% in 2006. One of the fastest-growing areas is Internet service providers within the information services group. Manufactures plan only a 3% increase, mostly auto plant construction. Manufacturing outlays for machinery and equipment remain at a record high level after an 11% hike in 2005. Petroleum refiners and primary metals will retrench, after the completion of large projects last year.

Household spending continued to post solid growth, despite a slowdown in auto sales and new home construction and sales. Spending was buoyed by continued strong income growth and a slight easing in energy bills. Labour income posted a second straight gain of 1.7%, with rising wage rates reinforced by a shift to full-time jobs.

The current account surplus rose to a quarterly record of $13.3 billion. The increase was driven by two developments that may endure for some time. First was an $3 billion jump in energy exports, lifting them over 50% ahead of a year ago, as the volume of exports has begun to respond to soaring prices. Second was a drop in interest payments on foreign debt, as both government and corporations have used part of their surpluses to pay down debt while the rising dollar has reduced the cost of servicing this debt.

The surplus of all governments leaped to an annual rate of $34 billion, the most since early 2004. Direct tax revenue from both persons and corporations rose at double-digit rates as incomes strengthened. Provincial coffers were also swollen by sharply higher royalties from oil and gas. The corporate surplus remained at a record high. While profits grew 13% from a year-earlier, undistributed profits jumped 24% as dividends did not keep pace with profits.

Labour Markets

Jobs grew by 0.2% in February, building upon their 0.1% gain the month before. However, all the increase was in part-time positions, partly at the expense of full-time, a reversal of recent trends. But employers will be encouraged to extract more hours from their labour force by a record - tying low unemployment rate of 6.4%. Unemployment in Alberta and BC hit 3.1% and 4.8%, respectively, historic lows in the current survey dating back to 1976.

Construction and finance and real estate added to their gains in January, raising growth in the first two months of the year to near 2%. Trade also posted a sizeable gain, while the public sector shrank.

Manufacturing jobs recovered about one-third of January’s large decline, but losses in this sector remain about 5% (or over 100,000) from a year ago. This left the total decline since their peak in early 2003 at almost 10%. This overall loss approaches the declines in 1981-1982 (only unadjusted data is available) and 1989-1991. But unlike these recessions, manufacturing output has continued to rise over the last two years. Instead of reflecting a drop in demand for manufacturing products, the recent slide in factory jobs reflects the emphasis employers have put on boosting productivity in the face of the squeeze on profit margins from rising input costs (notably energy) and lower prices for their exports from the rising exchange rate.

Employment growth was again led by Alberta, although its expansion shifted from resources and construction to services. A rebound in manufacturing in BC kept its year-over-year increase at 3.5%, matching Alberta’s pace. Newfoundland’s resource sector was buoyed by the completion of major mining projects. Employment remained sluggish in central Canada, although unemployment continued to fall as the labour force shrank.

Leading indicators

The composite leading index grew 0.5% in January, almost matching its 17-month high gain of 0.6% in December. Very strong gains in the stock market and housing starts at the start of the year gave a boost to the overall index. These increases offset continued sluggish export demand for manufactured goods.

The housing index turned up in January after three straight declines. The third-warmest January on record led to a sharp rise in housing starts. But the underlying trend of housing demand in Canada remains robust, especially compared with the slowdown under way in the US. Strong home sales supported further increases in demand for furniture and appliances. Sales of other durable goods remained weak, with auto sales slow to recover from the expiry of major incentive programs last fall and continued high gasoline prices.

Financial market conditions were buoyant to start the new year, with the stock market hitting a record high in January. Since then prices have retreated slightly, in line with a dip in prices for metals and energy. Strong demand for business services kept the services employment component expanding. Money supply growth remained robust.

Manufacturing remained lacklustre. Durable goods orders slowed sharply, especially for exports even before the exchange rate with the US moved sharply higher early in 2006. One encouraging sign for manufacturers is that they have reined-in inventories over the last two months, despite sluggish shipments growth. Factories also have boosted productivity sharply by slashing payrolls and freezing the workweek.

The US leading indicator continued to grow at a steady pace of 0.2%. While Canada’s exports of manufactured goods to the US have retreated, total exports south of the border have continued to rise, largely thanks to record demand for our energy products.

The upturn in Statistics Canada’s leading indicator at the turn of the year is consistent with the recent improvement in the OECD’s leading indicator for Canada. However, for most of 2005 the two indices diverged significantly, with sustained growth in our index while the OECD’s trended down for most of the year even as the economy grew steadily. The undue pessimism of the OECD index partly reflects its reliance on the gap between short-term and long-term interest rates, which gave a false warning about growth slowing last year. The problem originated when short-term rates rose while long-term rates were steady. In the past, this often preceded a recession when short-term rates hit high levels. However, the increase in short-term rates in 2005 reflected their return to more normal levels after touching historic lows after 2001. A similar phenomenon in the US also produced a false signal, leading the Conference Board to revise last summer how it integrated interest rates into its leading index.

Output

The year ended on an upbeat note, with real GDP growing 0.4% in December, its best increase since May. Output of goods led the way, notably manufacturing, while goods-handling industries led the growth of services.

Manufacturing output rebounded 1% from a small dip in November. Investment-related industries such as non-metallic minerals (notably cement and concrete) and machinery led the way. Construction nearly kept pace with manufacturing, due to strong gains in engineering and home-building. The increased flow of goods boosted demand for wholesale and transport activities.

The primary sector fell across the board. Forestry posted a third straight monthly drop of at least 5% as mill closures affected much of the country.

Mining was curtailed by reduced activity in the oilpatch. Overall, energy output fell 0.5%, partly as there was less need to replace US supplies damaged by hurricanes last summer. This offset a rebound in metal and non-metallic mining.

Elsewhere, business services continued to expand steadily. Travel-related services also posted solid gains as overseas visitors grew in number. Financial activity was buoyed by strong stock and real estate markets. Household spending was mixed, with declines in both gambling and movie attendance.

Household Demand

Overall, household spending growth was steady in the fourth quarter, despite declines in autos and housing. The resilience of demand reflects strong real income growth. Labour income was 6.3% ahead of last year, as tighter labour markets boosted earnings. Meanwhile, prices slowed in the fourth quarter, as energy took a smaller bite out of incomes.

Retail sales volume was flat in December, after two months of strong gains. This continues a 3-year pattern of weak Christmas sales, with the proliferation of gift cards pushing non-automotive spending into January. This affected demand for clothing most. Auto sales also remained weak at year end, and stayed sluggish in January.

Consumer demand for electronics remained the fastest growing area, fuelled by rapidly falling prices for big screen plasma and LCD TVs. Outlays also continued to grow for other furniture and appliances.

Housing starts rose 7% in January, matching their highest level in 2005. While unseasonably warm weather helped the increase, starts were already rising in November and December when weather was not a major factor. Existing home sales also picked up in January, led by gains in Alberta.

Merchandise trade

The fourth-quarter current account jumped $5.5 billion to a record level of $13.3 billion. Rising prices for energy products led the increase. Meanwhile, the deficit on investment income was the lowest since 1992, partly due to record profits from Canadian investments abroad and lower interest payments as the exchange rate appreciated. Foreigners stepped up both direct investment and equity purchases in Canada in the fourth quarter.

Exports continued to power ahead in December, up 4%. Half the increase originated in energy products, where prices rose sharply at year end.

But even excluding energy, exports posted a 2% gain. Lumber completed a solid quarter of 10% growth, fuelled by US demand after hurricane damage. Industrial goods were boosted by strong demand for metals, especially aluminum and copper. Exports of machinery and equipment continued to strengthen, helped by a sharp increase for aerospace products. Autos retreated after five straight gains.

Imports also ended the year on a strong note, rising 2.3% in December. Growth was driven by widespread gains for industrial products, led by metal ores imported to be refined in Canada (partly due to a refinery strike abroad). The boom in the oilpatch boosted demand for excavating machinery. Auto imports recovered only part of their recent losses, and ended the year below where they started.

Prices

The price of Canadian-made products jumped 1.3% in the fourth quarter, fuelled by the jump for energy exports. As a result, prices for our exports were 7% ahead of a year ago. Meanwhile, prices paid by spenders in Canada were little changed in the quarter, and slowed through the year as the cost of imports fell after the loonie appreciated.

The CPI rose 0.5% between December and January, lifting the annual rate of inflation to 2.8%. Most of the increase reflected higher energy prices, especially for gasoline and natural gas. After-Christmas discounting affected only clothing, as retailers were increasingly reluctant to lower prices in January when demand is rising due to gift cards.

Prices rose significantly faster in Alberta in the past 12 months. The 4.1% overall increase largely reflects Alberta’s booming house market. The cost of a new home (which is used to measure the replacement cost of owned accommodation) rose 16% in the past year, four times faster than in BC.

Commodity prices continued to retreat from their record high set in December. Energy led the retrenchment, as crude oil followed the January drop for natural gas prices. Prices for metals levelled off after their record-breaking performance to start the new year, when spot and futures prices jumped as inventories fell. Lumber prices were buttressed by the surge in construction in North America amid record warm winter weather.

The easing of raw materials prices will be welcomed by manufacturers, whose prices edged up 0.2% in January (excluding gasoline) but remain below the level of a year ago.

Financial markets

Corporate demand for funds fell in the fourth quarter amid a record corporate surplus. While investment spending continued to accelerate, it did not keep pace with profits. And firms spent less on inventories and interest and dividends.

The Toronto stock market dipped 2% in February, snapping a 3-month rally, which had taken it to record highs. The drop largely originated in mining and energy issues, which gave back some of their nearly 15% jump the month before.

The Canadian dollar hit a 14-year high of 88 cents (US) at the end of February, up a cent from January’s close. The increase accompanied essentially no change in interest rates, while rates edged up in the US.

Regional economies

Firms plan to step up investment the most in the prairie provinces. Manitoba leads the way in investment intentions with a 16% advance. Manufacturing is driving this increase, up 61%, followed by gains averaging about 20% in mining, utilities and transportation. Capital spending in utilities has nearly doubled over the last 2 years, powered by projects to supply electricity to Ontario. The booming oil and gas sector fuelled capital spending plans in Alberta and Saskatchewan. In Alberta, the recent surge in development of the oilsands led to a sharp increase in pipelines this year to carry the output of these projects to market.

Ontario was next with an 11% forecast increase in business investment. Over one-third of the hike was in utilities as the province grappled with a shortfall of electric power generation. Finance, retailing, transportation and mining also plan large gains. Ontario’s manufacturing sector raised intended outlays a modest 2%, mostly for the construction of new auto plants. Transportation equipment accounts for over one-third of manufacturing investment in Ontario.

Firms in Quebec plan the smallest increase in capital spending of the major provinces, up 3.5% after a drop in 2005. Manufacturers cut investment in both years. This reflects the recent completion of major smelting and refinery projects. These declines were only partly offset by modest gains in mining and utilities and sluggish spending by services.

The 7% increase in BC was led by transport and trade. This overcame surprising weakness in mining and oil and gas, despite high prices, and cutbacks in lumber. Transportation plans a major expansion to support increased passenger travel.

Investment plans were weak overall in the Atlantic region. Newfoundland, posted a decline, after the completion of major projects in mining and offshore oil last year. New Brunswick was hamstrung by steep cuts in its forestry sector, the largest in the region. Nova Scotia was the lone bright spot, buoyed by energy-related investments in utilities and manufacturing.

International economies

The United States economy was spurred by record warm temperatures in January. This gave a large boost to housing starts (up 15%) and retail sales (2.3%), and probably played a role in the 0.7% gain in manufacturing output.

But a number of indicators suggest these gains were unsustainable. Existing home sales fell for a fifth straight month in January, to their lowest level in nearly two years. Auto sales retreated 6% in February, erasing January’s gain due to slower car sales. New orders for durable goods fell sharply, aggravated by large declines for aircraft and other capital goods.

Real GDP grew 0.3% in the euro-zone in the final quarter of 2005, down from 0.7% in the third. For the year as a whole, the economy expanded by 1.3%. Business investment led growth, as consumer spending faltered at year end. Imports rose 0.9% in the quarter, almost double the gain in exports. Industrial production eked out a slight 0.1% gain in December, after a strong 1.4% rise in November, due to steady energy output. New orders weakened, although demand picked up for textiles and metal products. The unemployment rate was stable at 8.3% to start the new year, while the annual rate of inflation rose to 2.4%, up from 2.2% in December.

The German economy stagnated in the fourth quarter, after 0.6% growth in the third. Business investment posted its sixth increase in the past seven quarters. However, consumer and government spending both retreated, while import growth was twice as strong as the 0.5% gain in exports. Industrial production posted its second consecutive decline in December, with new orders also contracting. Inflation was unchanged at 2.1% in January.

France’s economy decelerated from 0.7% to 0.2% growth in the fourth quarter. Falling industrial production and sluggish consumer spending dampened growth. While exports were boosted by China, India and the US, imports soared due to high energy prices, resulting in a record trade deficit for the year.

Industrial production in Italy strengthened in December as new orders continued to expand. High labour costs have sparked capital investment, but eroded the competitiveness of exports. As a result, the trade deficit for 2005 ballooned to a level not seen since the 1980s. Inflation rose slightly to an annual rate of 2.2% in January.

Fourth quarter real GDP was steady at 0.6% growth in Britain. Industrial production slowed in December, after rebounding the month before. Imports continued to outpace exports as the oil deficit mounted. Still, their inflation was one of the lowest in the euro-zone in January at 1.9%.

The Japanese economy grew a robust 1.4% in the final quarter of 2005, buoyed by business investment and housing. Industrial production rose for the fifth straight month in December, the longest expansion since 1999. Consumer spending was boosted by higher wages and falling unemployment. The unemployment rate eased to 4.4% in December, while the job-to-applicants ratio advanced to 1 from 0.99 (implying jobs for everyone who wants one) for the first time in 13 years. Consumer prices saw their first back-to-back gain since April 1998 after seven years of deflation.

Hong Kong’s economy grew 1.9% in the fourth quarter, fuelled by consumer spending and exports. For the year, real GDP expanded 7.3%, down slightly from its 8.6% pace in 2004. China’s trade surplus narrowed only slightly in January to $9.5 billion (US) as exports remained strong despite the upward valuation of the yuan against the dollar.

Note

* Based on data available on March 10; all data references are in current dollars unless otherwise stated.