11-010-XIB
Canadian Economic Observer
March 2008

Summary table - key indicators

Overview*

Fourth-quarter real GDP growth slowed to 0.2%, punctuated by a 0.7% to drop in output in December. The decline was mostly driven by sharp cuts in car production, compounded by poor weather which hampered construction and other work outdoors. As well, the impending cut to the GST appears to have led households to delay some purchases until after the new year.

Final domestic demand strengthened 1.7% in the fourth quarter, its largest quarterly increase since the turn of the millennium. Consumer spending and business investment led this advance. These gains were driven by higher real incomes arising from further increases in the terms of trade. The strength of domestic spending was an important bulwark against the first quarterly drop in exports of the year, while imports surged as the loonie surpassed parity with the US dollar. Higher imports were evenly split between goods and services, the latter reflecting increased travel abroad.

There are several indications that the economy quickly shrugged off its drop in December and began growing again in the new year. Housing starts and auto sales posted strong gains. The stock market in February rebounded from its dip in January, reflecting one of the largest jump in monthly commodity prices during the current boom that began 6 years ago. The leading indicator began to grow again in January after a decline in November and stalling in December. Most importantly, firms expanded payrolls in both January and February, consistent with a pick-up in investment plans for 2008.

Business investment

Firms plan to boost nominal business investment about 6% in 2008 according to the annual survey of investment intentions (this may translate into a larger gain in volume, if prices fall as they often have since the loonie started rising in 2003). The increase bettered last year’s hike, and was evenly spread between construction and machinery and equipment.

More importantly, higher investment signals that firms intend to spend more for a sixth straight year. In past investment cycles, spending typically started to wane in the fifth year of growth. Of course, past cycles never saw the boom in commodity prices that also is entering its sixth year, and remains the driving force behind investment growth.

Energy continued to fuel higher investment, rising another 10% in 2008. The oilsands and pipelines spearheaded this gain, followed by steady gains for utilities. Energy investment represents 38% of all business investment in 2008, down slightly from its peak of 40% in 2006. It was less than one-quarter as recently as of 1999.

In 2008, oilsands producers intend to invest $19.7 billion, up 23% after a 31% hike in 2007. This exceeds the total investment plans of $19.6 billion by all manufacturing industries. Just a decade ago, oilsands investment was less than one-tenth capital outlays by manufacturers ($1.4 billion versus $21.6 billion in 1998).

This shift in investment growth from manufacturing to the oilsands dramatically summarizes one of most fundamental structural changes in Canada’s economy in the past decade. Investment in the oilsands has risen from $5.2 billion in 2003 to a projected $19.7 billion in 2008: this is the largest 5-year increase ever posted by any major sector (let alone individual industry) outside the oilpatch, including the current surge in transportation and mining, the $9 billion hike at the peak of the manufacturing boom in 2000 and the $10 billion Y2K-related splurge by finance ending in 1999.

Oilsands investment has surpassed manufacturing because of its rapid growth, not because manufacturing has been weak. By its own standards, manufacturing investment remains at a high level. Firms plan to spend 7% more on factories this year, mostly on productivity-enhancing machinery and equipment. This $19.6 billion vote of confidence in the future of manufacturing in Canada was the highest investment since the peak of the ICT boom in 2000, and was the most of any industry outside of the energy sector. A majority of manufacturing industries (11 out of 20, up from 6 in 2007) plan to spend more, led by refiners of oil and metals and capital goods industries. The auto industry plans to retrench slightly, partly due to the winding down of work on a new factory.

While energy has become the dominant sector in business invest­ment, metal ore mining remains the fastest growing. Since metals prices turned up in 2003, investment has closely tracked the rise in profits. With back-to-back gains of 33% in each of 2007 and 2008, investment in metal ores has almost tripled since 2003. The total investment of $4.7 billion in metals is concentrated in gold, nickel and copper mines.

Among services, only transportation planned double-digit investment growth in 2008, reflecting the growth of pipelines needed to connect the oilsands to their markets (these investments will allow pipelines to increase their capacity by one million barrels a day by 2009). Wholesale and retail trade plan modest expansions. Most other services plan little or no growth, including recreation, finance, business services, and accommodation and food. While most of these industries are not very capital intensive, this is a very muted response to growing labour shortages and the upward pressure on prices in this sector.

Outside of energy and metals, most resource sectors trimmed investment plans for 2008. Steady cuts in lumber and paper are not surprising in view of the over-capacity in these industries. A drop in capital outlays by crop farmers is more surprising, and may not reflect soaring prices for grains early in the new year.

Labour markets

Employment advanced another 0.3% in February, matching its gain in January after a lull in December. All of the increase was in full-time positions, and was concentrated in private sector payrolls for the second month in a row. With a similar gain in the labour force (particularly among youths), the unemployment rate remained at its recent low of 5.8%.

Construction led industry growth with a second straight increase of 20,000 jobs. Services picked up with a 0.4% gain, driven by widespread advances in trade, finance, business services and the public sector. Manufacturing gave back all of the ground gained in January, while natural resources continued to retreat.

Ontario dominated job growth, returning its year-over-year increase to near the national average of 2.2%. Construction and business services led the way, offsetting renewed losses in manufacturing. Construction remained buoyant in western Canada, where Manitoba, Saskatchewan and BC all continued to post double-digit growth year-over-year (Alberta was a notable exception). Manufacturing also dampened Quebec, which relied solely on services for growth. Employment fell slightly in both BC and Alberta, especially in natural resources and construction where the coldest weather in years in the northern parts of these provinces forced the suspension of work outdoors (including projects in the oilsands).

Leading Indicators

The composite index rose by 0.2% in January, after December was revised up to no change. The upturn was broadly-based, with five of the ten components rising versus only two in December. Household spending remained the strongest sector of the economy, more than offsetting the sharp drop in the stock market at the start of 2008.

December’s sharp decline in the housing index moderated substantially in January. The largest turnaround was in the housing index, which swung from a 2.6% decline in December to a 1.0% gain in January. Housing starts returned to more normal levels. The underlying strength of the housing market was reflected in a 1.1% gain in furniture and appliance sales, their most since July 2006. Demand for other durable goods began to firm even before the GST was cut on January 1. The rebound of consumer demand in the new year also was reflected in a recovery in employment in personal services, which led the turnaround in overall service jobs in January.

The outlook for manufacturing industries remained mixed. The leading indicator for the United States continued to fall slowly in response to weakness in housing and autos. However, new orders for goods manufactured in Canada jumped 3.1%, driven by ongoing strength in capital goods, especially aerospace. Meanwhile, inventories remained well under control, helping raise the ratio of shipments to inventories.

Output

Real GDP fell by 0.7% in December, its largest monthly decline since the blackout in Ontario in August 2003. Auto assemblies tumbled 27%, due to a combination of model changeovers at some plants (to take advantage of their normal down-time over the holidays) and temporary shutdowns due to poor car sales in the US. Simulations with the Input/Output model show that the direct and indirect effect of the drop in auto output lowered GDP by 0.5 percentage points. The drop in auto output rippled through the economy, from wholesale trade and transportation to feeder industries in manufacturing. Auto output recouped nearly half these losses in January, as the model changeovers were not completed until late in the month and shutdowns due to sluggish sales rotated from cars to trucks.

But manufacturing was weak across the board. Clothing and lumber continued to shrink rapidly. Even industries that have profited from the resource boom (such as construction and mining machinery) posted large declines. Heavy snows in eastern Canada slowed shipments.

Severe snow storms also hampered in work done primarily outdoors, such as home construction (-0.4%), mining (-1.2%) and rail transport (-6.6%). Poor weather also discouraged travellers from the US, which hurt services such as gambling and restaurants.

Services not dependent on handling goods or fair weather fared better in December. Finance and business services grew slowly. Public sector output rose steadily.

Household demand

Retail sales volume rose 0.6% in December, their third straight increase. Most of the increase was spent on autos, which began to climb in December as firms offered price cuts in anticipation of the cut in the GST on January 1. Still, many buyers chose to wait for the tax cut to take effect, and auto sales jumped sharply in January. Retail sales in Canada also were helped by an 8% drop in cross-border shopping trips in December.

Non-automotive sales were lacklustre, which is not surprising given the amount of money spent on autos. As well, heavy snow storms may have hampered consumers from going out. Clothing purchases fell for the second time in three months. Computers sales posted a rare decline, although demand for TVs solidified their place as the fastest-growing segment of retail sales in 2007 (with an overall gain of 16% in volume).

Housing starts rebounded 25% in January from a 23% drop in December. December’s results were adversely affected by unusually severe winter weather in some parts of the country. All of January’s recovery was in multiple units, which are the most affected by weather.

The market for single-family dwellings started the new year on a weak note. New home sales fell sharply, leading to an increase in the overhang of unsold vacant units. This helped dampen starts of singles for a second straight month. Existing home sales stabilized after a slow fourth quarter. The once red-hot markets in Alberta have cooled significantly.

Merchandise trade

The current account balance swung to a deficit in the fourth quarter. This resulted from a narrowing of the goods surplus and a widening of the services deficit, while investment income remained stable. The deterioration in the goods balance originated in exports falling more than imports in the quarter, with both declines partly due to shutdowns in the auto industry at the end of the quarter. The increase in the services deficit reflected increased travel abroad by Canadians.

In December, exports fell 3.1% while import growth was held to 0.7% by lower auto production. Energy exports showed a strong increase. Exports of canola and wheat, as well as fertilizers and agricultural machinery, which have benefited from the global agricultural boom, also ended the year on a high note.

Canadian farms, like their foreign counterparts, have stepped up investment in agricultural machinery as revenues have risen. While also pushing up domestic machinery orders, this agricultural demand has ramped up imports to nearly $1 billion in the fourth quarter, a high unrivalled since 1997. In addition to this demand for foreign machinery, a gain in energy imports in December helped to offset the temporary dip in auto parts imports.

Both exports and imports advanced to record highs in 2007, with exports posting gains of 2.1% over 2006 to reach $465 billion and imports rising 2.8% to $416 billion. Exports of natural resources, notably grains and metals, as well as manufactured goods (such as chemicals, plastics, refined metals, aerospace equipment and canola oil) posted stellar gains for the year. For imports, gains were registered for all sectors.

Prices

The implicit price index for GDP rebounded 1% in the fourth quarter, after a dip in the third. Construction remained the major source of upward pressure on prices. Most other prices were dampened by a 4% drop in the cost of imports: consumers paid only 0.2% more, while the price of investment goods fell for a third straight quarter. Export prices also fell for the third quarter in a row, as the sharp rise in the loonie outweighed higher prices for commodities such as energy, food and metals.

Consumer prices edged up 0.1% between December and January, slowing the annual rate of inflation to 2.2%. There was increasing upward pressure on food and energy prices: excluding food and energy, prices fell, partly due to the 1-point cut in the GST rate.

Energy prices jumped 0.6%, as motorists paid more to fill up at the pump at a time when crude oil hit record highs on world markets. The cost of food turned up, after slowing through most of 2007. The largest monthly increase was for bread, pasta and cereals, as the recent surge in the price of wheat began to affect consumers.

The cost of durable and semi-durable goods both fell about 1% in January. Auto prices were discounted for a second straight month, sparking sharply higher sales in both months, while prices also dropped for a wide range of other durable goods and clothing. The cost of services eased from their recent run-up, reflecting a slowdown in housing prices and the effect of a lower GST in areas such as restaurants.

Commodity prices took off again in February, posting one of their largest monthly jumps since the current boom began six years ago. Grain products led the way, with wheat soaring as more countries restricted exports to control domestic prices. But commodity prices were strong across the board. Oil prices closed above $100 (US) a barrel, while a cold snap in the US boosted natural gas. Metals also advanced, led by the fourth straight increase for copper.

Manufacturing prices in January rose about 1% for the third straight month. Most of the in­crease reflected the surging price of metals, gasoline and food. As well, a lower exchange rate gave a small boost to prices for many exports except for lumber. Manufacturing prices have recovered abut half of their decline when loonie was soaring during the summer and fall of 2007.

Financial markets

The stock market rebounded 5% in February, recovering all of its losses at the start of the year. However, most of the rebound was confined to metals and energy. Both soared at a double-digit rate on the strength of surging commodity prices on world markets. Most other sub-indices fell marginally. The recovery in Canada contrasts with continuing losses in the US, notably in its troubled financial sector.

Interest rates and the exchange rate were little changed in February. The turmoil in financial markets in January accompanied a shift in business financing from stocks to bonds and short-term paper. The sharp increase in overall business credit is consistent with the stated intention of firms to step up business investment in 2008.

Regional economies

The year ended with stronger household demand in virtually all parts of the country, especially in Ontario in marked contrast with the lacklustre performance of the past two years. As in November, Ontario led national retail sales growth with a second increase of over 1% in December. This was despite the loonie exceeding parity with the US dollar and the province’s cities being the most exposed in the country to cross‑border shopping (because of their proximity to the border). Spending was driven by the low cost of goods, with Ontario having the smallest increase in the country (up only 0.3% in 2007), while growth in labour income was substantial (over 3% between September and December 2007). On the housing side, starts more than made up for their one-third drop in December that resulted from major snowfalls. Manufacturing was hard hit by the drop in autos.

Snowstorms had a negative impact on retail sales in Quebec in December. These storms also slowed manufacturing shipments due to the closure of several highways for several days. Some 15 of 20 manufacturing industries recorded declines, with petroleum the main exception due to the cold weather. As in the rest of Canada, housing rebounded in January with starts recording their highest level since July. The housing sector was particularly strong in Quebec in 2007, with sales of existing homes exceeding growth in Ontario, the Prairies and British Columbia.

The economy of the Prairies continued to pick up after a lull last fall. Housing starts rebounded after hitting their lowest level of the year in December. Retail sales jumped another 0.8% following the 1.3% increase in November. As well, petroleum remained a source of strength at the start of a cold winter. Overall, shipments fell slightly, driven by the ongoing weakness of forestry products.

Manufacturing remained lacklustre in British Columbia in December. The decline was again led by the forestry sector but most industries experienced a slowdown. BC was the main source of Canada’s sluggish exports in 2007, with an annual decline of 7.9%. Exports rose almost everywhere else, except Quebec. Household demand remained strong with retail sales up 1.1% in December and housing starts climbing 18% in January.

International economies

In the United States, despite continued weakness in the housing market, the real economy’s resilience carried over into January. Higher exports of capital and industrial goods combined with a lower import bill resulted in a shrinking trade deficit. Retail sales and industrial production posting small gains. The contrary signals of a drop in payroll employment coupled with a drop in new manufacturing orders were mitigated by the occurrence of significant upward revisions to the payroll figures of late and higher orders in December.

Housing starts, sales and prices maintained their downward trend into 2008. Permits fell 3% while new home sales dropped 2.8%. Existing home sales were relatively stable, declining only 0.4% while housing starts edged up 0.8%. However, a temporary stabilization has occurred at several points since the beginning of the housing turmoil, making it premature to suggest a bottoming-out.

Retail sales rose 0.3% in January. Most the month’s increase originated in autos, although clothing, drug and grocery stores all registered gains. Industrial production eked out a 0.1% rise. Manufacturing output remained stable after two consecutive increases, with falling output in wood and textiles offsetting gains in electronics, aerospace and petroleum. Colder temperatures boosted utility demand.

The US trade deficit narrowed to $58.8 billion in December as US imports slipped 1.1% (despite higher oil prices) while exports rose 1.5%. Much of the fall in imports was concentrated in autos, served primarily by Canadian plants which had scheduled shutdowns in December. Elsewhere consumer and business demand remained firm. New orders for core capital goods posted a third straight gain in January. For the whole of 2007, exports outpaced imports, resulting in the annual trade deficit shrinking for the first time in five years.

Economic growth in the euro-zone was halved in the last quarter of 2007, restrained by the strong euro, higher interest rates and fall-out from global financial turmoil. Real GDP rose 0.4%, after a 0.8% gain in the third quarter. Industrial production fell again in December as a sharp drop in capital goods could not offset increased energy output. New orders also retrenched, wiping out their gains of the previous two months. Demand was down across the board with the exception of a slight gain in electronics. External trade fell into a deficit in December as the energy shortfall surpassed surpluses for machinery and vehicles. Exports to the US and Japan continued to slide. Consumer demand contracted for the third straight month in December with spending down in every major sector. Prices continued to climb, however, pushing inflation to 3.2% in January, while the unemployment rate was stable at 7.1%.

The pace of growth in Germany slowed in the final quarter as real GDP rose 0.3%, down from 0.8% in the previous quarter. Industrial production rebounded in December, after three months of stagnation, led by manufacturing and mining. New orders turned down despite steady export demand and strong business investment. Consumer spending fell in December when higher energy and food prices deterred shoppers, but inflation eased slightly to 2.9% in January.

Real GDP in France grew 0.3% in the fourth quarter, down from its 0.8% advance in the third. Industrial production rebounded in December, while new orders fell for the fourth time in five months. Consumer spending strengthened after several lacklustre months as the unemployment rate continued to ease, dropping to 7.8% in January.

The British economy expanded by 0.6% in the fourth quarter, fuelled by government and household spending. For the year, the economy grew 3.1%, its fastest pace since 2004. Industrial production fell in December for the second straight month as manufacturing output contracted. The recent depreciation in the sterling helped exports, particularly for capital goods. Consumer demand picked up in January after a sluggish year end, buoyed by widespread discounting. However, edged up due food and energy.

Japan’s economy grew 0.9% in the fourth quarter, as a surge in business investment and strong exports to other Asian nations (particularly China) offset a slowdown in US demand. Industrial production was robust in December, boosted by strong domestic and foreign demand. Housing remained dormant, however, dampened by strict new government regulations on earthquake resistance.

China’s economy continued to power forward. January’s trade surplus hit $19.5 billion, up 23% from a year earlier. Still, import growth continued to outpace exports for the fourth straight month. Inflation hit an 11-year high as severe winter weather resulted in transport bottlenecks and commodity prices rose on world markets.

Note

* Based on data available on March 7; all data references are in current dollars unless otherwise stated.