11-010-XIB
Canadian Economic Observer
June 2003

Summary Table - Key Indicators

Overview*

Canada continued to lead the G7 in growth, as real GDP in the first quarter rose 0.6%, about equal to the average quarterly gain over the past year. Growth early in the second quarter was dampened by the fall-out from SARS and the Iraq war, which was enough to lower employment, especially in travel-related industries such as accommodation and food.

Aggregate demand continued to be split between robust household spending (notably for housing), and sluggish exports and business investment. The major new development in the quarter was an upturn in inventories, especially of motor vehicles when sales slowed.

But there were a number of important shifts in prices and in savings. In particular, the terms of trade hit a high in March, one result of the rising exchange rate as well as rising energy prices. Private and public savings continued to climb and the external trade surplus rose, all the mirror image of trends in the US.

The appreciation of the exchange rate has already had a significant impact on prices, especially for tradable goods. The terms of trade (the ratio of export to import prices) reached 111.3 in March, its highest level on record back to 1997. Export prices have jumped 6.5% since last August, as gains for energy outweighed the moderating impact of the exchange rate on other exports. Import prices have fallen 4.2% in the last seven months, as all non-energy prices were pushed down by the dollar. This drop in prices fed through to the consumer sector by April, when the costs of durable and semi-durable goods (such as autos, electronics and clothing, where imports dominate) fell below their level of a year earlier. Together with lower energy costs in April, this sharply reduced the inflation rate to 3%.

The corporate sector again boosted its savings even as fund-raising slowed. Net lending rose to over $52 billion (at annual rates), the most on record stretching back four decades and lifting private sector savings. This reflected sharply rising profits and ongoing restraint on outlays. Led by energy, corporate profits jumped 26% from a year earlier: undistributed profits soared 46%, largely because firms cut dividend payments. Meanwhile, spending on plant and equipment dipped 2.4%, with falling prices for imports dampening outlays. Firms used their fiscal surplus to further restructure their balance sheet by lowering the ratio of debt to equity and lengthening the term structure of debt. For example, firms paid down short-term debt at a rate of nearly $1 billion while bond issues rose $28 billion. The weak stock market continued to hamper fund-raising: equity issues by non-financial corporations totalled only $18.8 billion, a far cry from the $67 billion raised at the peak of the boom late in 2000. Overall, firms raised the smallest amount of funds since they emerged from recession in 1992.

Net lending by governments in Canada rose to an annual rate of $21.7 billion, returning to its highs set before the terrorist attacks (and up from $9 billion last year). Revenue growth picked up to 7% in the past year, swollen by a 34% gain in corporate taxes as profits soared, while royalties on energy rebounded. Personal taxes rose only 1.4%, less than employment, as tax rates continued to fall. Meanwhile, spending rose at just half the rate of revenues, with lower unemployment helping to cap the growth of transfers to persons at a 4-year low of 1.6%, while interest payments continued to fall.

Our quarterly current account surplus nearly doubled to $32 billion in the first quarter. While higher energy prices boosted export earnings, the falling cost of imports made the largest contribution to the surplus in goods. Most non-energy exports weakened as US demand was sluggish. The higher dollar also reduced the cost of servicing our debt to non-residents. Canadian investors sold US stocks and bonds in the first quarter, adding to the downward pressure on the US dollar. Foreign investors moved a net $8.5 billion into Canada, mostly in bonds.

The travel deficit in the first quarter increased for the first time in a year. Foreign travellers spent 5% less, as visitors were deterred by the outbreak of SARS in March and the war in Iraq. Visitors from the US tumbled 7%, also discouraged by the diminishing purchasing power of their dollar. Canadians spent 1.5% less abroad. Increased security measures at the US border played a role, as Canadians made 4% fewer trips to the US (despite a rising exchange rate) even as they made a record number of trips overseas.

Labour Markets

Employment in May dipped by 0.1% for the second month in a row, with all of the drop in full-time positions, which had been growing steadily so far this year. However, most of this decrease was concentrated among youths. A continuing influx of youths and women into the labour force pushed up the unemployment rate to a 15-month high of 7.8%.

SARS-related losses in health care and accommodation and food in April were partly recouped in May. Still, overall employment in services fell, the result of cuts elsewhere in the public sector, transport as well as finance. Jobs were stable in goods-producing industries, leaving manufacturing down nearly 2% so far this year.

Quebec and New Brunswick absorbed the brunt of job losses in May, and have seen the largest increases in unemployment so far this year. Ontario did not recover any of its drop in April, as a rebound in industries most affected by SARS was offset by losses in transport. Alberta posted the only significant gain in jobs, buoyed by its energy and public sectors (the survey was taken before the mad cow incident; Alberta is home to 43% of Canada’s beef herd).

Leading indicator

The composite leading index rose by 0.1% in April after a 0.2% gain in March, continuing the string of small gains that began in the summer of 2002. Household demand continued to grow enough to offset weakness in manufacturing, where export demand has slowed. Overall, four components posted gains in April, the same as in March. Four components fell while two were unchanged.

Housing fell again in April after turning down in March, as housing starts retreated from their impressive high set in February. They now are situated at about their average level in 2002, which was the best in
13 years. At the same time, services employment decelerated sharply from 0.5% growth in March to 0.1% in April, as the accommodation and food industry was hard-hit by the SARS crisis, especially in Ontario. Conversely, sales of durable goods snapped out of a 9-month slump, led by autos.

Two of the three manufacturing components fell. New orders for durable goods trended down for a sixth straight month (off 0.8%), while the ratio of shipments to stocks returned to its negative trend with a 0.6% decline after a brief one-month upturn. A majority of industries participated in the retreat (especially in the investment and export sectors), led by non-automotive transportation equipment where aerospace tumbled by 30% over the last two months. Manufacturers cut their labour requirements again by trimming payrolls, as the average workweek has been stable for nearly a year. This pessimism was moderated by widespread gains in the Toronto stock market in April, led by double-digit gains for technology stocks.

The US leading indicator levelled-off after three straight gains. The components related to household demand fell further. Housing was particularly weak, as vacancy rates rose slightly above their long-term average, while real disposable income in February and March posted its first back-to-back losses since the September 2001 attacks. Employment in April fell for the third month in a row while the average workweek contracted sharply.

Output

The volume of GDP stalled in March, after solid gains to start the new year. Much of the weakness appears to be SARS-related. Accommodation demand fell almost 1% as the number of foreign visitors tumbled 5%, while restaurant sales also dipped. Fewer visitors coming to Canada meant air transport fell 3%. Demand in all these industries began to shrink in January.

The ICT sector shrank again in March. But for the first time the drop was led by services and not manufacturers. Demand for telecom services fell for the second month in row after years of unbroken gains, while computer services also posted back-to-back declines. Information services slid for the third month in a row. Elsewhere, the financial industry was weighed down by sluggish trading volume everywhere but in real estate. Other personal services remained healthy, notably gambling, sports and arts.

The primary sector remained a pillar of strength, fuelled by demand for oil and gas. Construction continued to ride the boom in home-building. Manufacturing output rebounded by 0.4%, continuing to oscillate around a flat trend since July. Auto assemblies and ICT goods were little changed, while aerospace assemblies fell for the ninth straight month as global demand for air transport shrank. Resource-based industries were one bright spot, notably lumber and paper.

Household Demand

Household demand remained the engine of growth in the first quarter. Real incomes were boosted by strong job growth, while borrowing was swollen by robust housing demand and low interest rates.

Retail sales volume dipped 0.8% in March, following three consecutive solid gains. All of the retreat originated in slower auto sales, completing their worst quarter since the terrorist attacks in 2001. Stepped-up rebates lured some customers back in April.

Non-automotive demand remained strong. Furniture and appliances were buoyed by robust housing demand, while falling prices stimulated computer sales. Clothing and gas stations completed their best quarterly advance in years, the beneficiaries of a cold winter.

The housing market continued to level off at a high level of activity. Housing starts in April dipped 6% to an annual rate of 207,700, and so far this year are running slightly behind last year’s pace despite a record-breaking performance in February. The slowdown in starts is consistent with a moderation of demand. New home sales fell again in April, continuing a downward trend so far this year and leading to the largest jump in unsold units in over three years. The existing home market also cooled for a third consecutive month, with most major markets softening. The slack in demand may be helping to cap prices; new housing prices edged up only 0.1% in March, the smallest monthly increase since October 2001.

Merchandise trade

The nominal trade surplus in goods jumped by over $1 billion in March. Much of the increase originated in US demand for energy, which raised the price we received for our exports. The recent sharp appreciation of the dollar dampened the cost of our imports.

Export earnings rose by 2.8% in March, as higher prices inflated energy shipments by 15%. This was the seventh straight increase for energy, leaving exports at nearly double their level of a year ago.

Non-energy exports eked out a small gain, largely the result of a rebound by metals and aircraft. Weak US demand continued to hamper key sectors such as autos, ICT equipment and lumber.

Imports fell 0.5% due to a 2.2% drop in prices. The downward pressure on prices is even stronger when allowance is made for the record level of oil prices. Imports of machinery and equipment, and consumer goods both rose, despite sharp drops in their cost. Slower auto sales in Canada restrained imports in this sector.

The terms of trade continued to swing sharply in Canada’s favour. Import prices fell for a fifth straight month, the product of a rising dollar lowering the cost of all non-energy imports. Meanwhile, export prices have risen in seven of the last eight months, as energy prices soared. The price of non-energy exports has fallen, especially for goods such as autos and resource products that are priced in US dollars (the rising exchange rate implies that US dollars earned from exports are converted into fewer Canadian dollars).

Prices

The price index for GDP jumped nearly 2% in the first quarter, inflated by energy exports. Canadians paid only 0.5% more for goods and services, with the rising cost of energy largely offset by falling prices for imports.

The consumer price index fell 0.7% between March and April, curbing the annual rate of inflation to a 7-month low of 3.0%. Lower energy prices led the way, as the cost of gasoline tumbled while electricity customers in Ontario received a rebate to compensate for hikes last autumn.

The cost of durable and semi-durable goods also dipped in the month, falling below their level of a year ago. Furniture and appliances, autos, computers and clothing saw price declines. All these sectors share a high import content, leaving them positioned to take advantage of the rising exchange rate to lower costs. Conversely, prices for services outside of housing (which are largely insulated from trade) jumped 5% year-over-year.

The rising exchange rate intensified the downward pressure on industrial prices, off 1.4% in April. The impact was particularly strong for exports of autos and lumber. Lower gasoline prices also contributed about half of the decline. Overall, prices fell for 14 of 21 commodities. The 7% drop in raw materials prices was even more widespread, as none of the 7 components posted an increase in April.

The Bank of Canada’s commodity price index recovered some of the sharp drop posted in April. The rebound was evident in all components, led by crude oil, which returned to nearly $30 (US) a barrel, as well as aluminum and wheat. The index is being updated to reflect new production patterns in the 1990s (for example, aluminum’s weight in the index surpasses copper, while cod has disappeared altogether).

Financial markets

The highlight of the month was the surge in the exchange rate, which lifted the Canadian dollar 5 cents (US) to surpass 74 cents at mid-month, before easing to 73 cents. The dollar had posted a cumulative gain of 5 cents in the first four months of the year. Overall, the trade-weighted value of the US dollar fell less rapidly than it did against the euro and the loonie, largely because China maintains a fixed exchange rate with the US and the yen remains low.

Domestic money and credit flows in April marked a pause in some of the trends of the first three months of the year. A stop to the shift into money market funds that accompanied higher short-term rates was one example, the mirror image of an end to the outflow from non-money market funds. As well, the pick-up in short-term business credit was reversed in April, as bank loans hit a new low for the year. This was offset by firms issuing more bonds and stocks.

The Toronto stock market posted a broadly based 4% advance in May, bettering its gain in April. Every subgroup was up, led by another double-digit increase for information technology. Resources bounced back, after being the only source of weakness the month before.

Regional economies

Alberta, which rose from one of the lowest-ranked to one of the most vigorous economies late in 2002 because of a flourishing energy sector, continues to lead the pack. In March, energy boosted its total exports by 60% from the previous year, equally due to both price and volume. Outside the energy sector, shipments increased across the board, reflecting a pick up in domestic demand after labour income growth reached almost 10% (at annual rates) in the fourth quarter of 2002. In contrast with other areas of the country, housing remained at the high levels it reached in February.

At the other end of the spectrum, British Columbia continues to lag behind. The slump has persisted in forestry (which accounts for half of the province’s manufacturing sector) and in tourism – two of the province’s most prosperous industries at the turn of the decade. Lumber shipments were at their lowest level since May 1978, down 30% from their peak in January 2000. Employment in food and accommodation, which has declined continuously since March 2002, suffered another blow when the WHO placed Canada on its list of countries affected by SARS. The drop in retail sales was the most pronounced in the past five years, a period throughout which households dipped into savings to finance consumption.

Mixed trends were evident in Ontario. Household demand weakened at the same time as employment, while higher auto exports gave a boost to the manufacturing sector. In March, manufacturing shipments regained all the ground they had lost in February, with a majority (6 out of 9) of durable goods industries recording an increase. Overall shipments increased markedly during the first quarter, reversing declines in the second half of last year.

After leading the country’s growth last year, housing in Quebec slowed in April as it had in March. Montreal posted a drop in house prices for the first time since June 2000. Quebec was alone in posting higher retail sales in March, buoyed by higher confidence levels. Lower exports to the US had a dampening effect on manufacturing, particularly integrated circuits and lumber. The closing of a major metal processing plant at the end of the month was another source of weakness.

International economies

Industrial production in the United States in April continued to retreat, and the second straight drop of 0.5% left output below the level of a year earlier for the first time since last June, after a small advance late last year. Manufacturers led the cuts, notably the auto industry within consumer goods with a third straight decline. Losses were widespread in business equipment, especially communications equipment. Weak capital spending was also evident in an eighth straight retreat by construction materials. Overall, only 41.0% of industries raised output last month, the smallest share since June 2001. New orders for durables in April were not encouraging, falling 2.4%. Defense industries plunged 19% as the war in Iraq came to an end. But autos and nondefense capital goods both fell. Computers were one bright spot, reversing a 2-month slide.

The US deficit in trade in goods and services continued to swell, from $40.3 billion in February to $43.5 billion in March, the second largest after the $44.9 billion in December 2002. Higher oil prices accounted for all of the deterioration, as the non-oil deficit levelled off over the last five months. However, trade in capital goods remained sluggish in both directions.

Retail sales in April held on to all of the 2.3% gain made the month before. Auto sales accelerated in both months as dealers offered the widest range of incentives since just after the terrorist attacks. Non-automotive sales gave back much of their 1.5% March advance. Only a small part reflected lower prices for gasoline, as demand was weak for a wide range of products. A 7% drop in housing starts did not help, continuing their wide monthly swings around a generally flat trend so far this year. A 20% jump in units authorized but not started in the past year may reflect labour shortages in some areas, especially with the call-up of reserves.

The government deficit in the US continued to grow in the first quarter, rising to $427 billion (at annual rates). Virtually all of the deterioration from a surplus just two years ago originated in the federal government, where revenues fell 9.4% while spending rose 12.9% (about one-third of which went to national defense).

Real GDP was flat in the euro-zone in the first quarter of 2003, but gained 0.8% on a year-over-year basis. Industrial production dropped 1.2% in March, after two consecutive gains, led by lower energy output. The weakness in output was widespread and occurred in nearly every country in the zone. Capital and consumer goods also fell, partly as a result of the continued strength of the euro. The external trade surplus narrowed further in March, as the energy deficit grew and foreign demand for machinery and autos waned.

The German economy contracted 0.2% in the first quarter, after a small dip in the previous quarter. Domestic demand remained weak as unemployment continued to mount in April, hitting its highest rate (10.7%) since unification. Even though Germany maintained the largest external trade surplus in the euro-zone in March, its industrial production fell 2% and manufacturing orders dropped 4%. Domestic orders saw their second-largest decline since the series began in 1991, while foreign orders fell for the second straight month as the euro continued to soar on world markets. Inflation fell from 1% in April to 0.7% in May, largely due to falling oil prices.

Industrial production in Britain fell in May after a slight rebound the month before, while steady strength in the pound resulted in the largest external trade deficit in Europe. Domestic demand picked up in March, aided by a boost in wages as companies paid out their annual bonuses. Unemployment and inflation remained steady, prompting the Bank of England to leave interest rates unchanged.

Nominal GDP in Japan contracted in the first quarter as deflation intensified. Output volume stalled after three consecutive quarters of slowing growth, as the Iraq war and the SARS virus dampened demand. Exports and business investment, the previous engines of growth, both retrenched. Consumer spending posted a slight gain despite continued price deflation. The GDP price deflator fell 3.5% from a year earlier, which was the largest drop on record, and in turn, pushed the five-year government bond yield to a record low of 0.185%. Industrial production fell 1.2% in April. The trade surplus expanded, however, aided by strong exports to China, even as trade with the US continued to decline.

Growth continued to slow in the Southeast Asian economies at the start of the year. The SARS epidemic, which took hold in mid-March, further disrupted trade and spending. The Philippine economy slowed to 4.5% growth on a year-over-year basis and contracted 0.5% from the previous quarter. South Korea’s economy shrank (0.4%) for the first time in two years as consumer spending slumped which prompted the central bank to cut interest rates for the first time in a year. Hong Kong saw its jobless rate rise to 7.8% from February to April, compared with 7.5% in the three months to March, as the SARS outbreak dampened tourism and trade.

Mexico’s GDP grew 2.3% in the first quarter from a year earlier, but was down 0.5% from the previous three months, as the slowdown in the US economy continued to dampen export demand.

* Based on data available on June 6; all data references are in current dollars unless otherwise stated.

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