11-010-XIB
Canadian Economic Observer
August 2005

Summary Table - Key Indicators

Overview*

Output followed jobs in accelerating in the spring. Mining led the increase, overcoming several supply disruptions during the winter. The boom in commodities sent investment in non-residential construction soaring in Western Canada. Household spending took a breather in May, although housing and autos sales turned up again in June.

Investment in non-residential building rose 2.6% in the second quarter, thanks to record spending in Alberta and BC (up 13% and 19%, respectively). The spate of new industrial, office and shopping centre projects was reflected in a double-digit employment gain in professional, technical and scientific services in these provinces: this industry includes areas such as architectural and legal services which are required as firms draw up plans for expansion. Conversely, investment slumped in central Canada, due to cuts in industrial building.

Commodity prices hit another record high, driven by crude oil and metals. Double-digit growth in these sectors fuelled further sharp gains in the stock market. Despite high commodity prices and a 30-year low unemployment rate, there has been no upswing in consumer prices or average hourly earnings in the past year.

The leading indicator pointed to continued solid growth in the second half of the year. The leading index will be even stronger when a major upward revision to the US index is incorporated in July (see the two figures below). The US leading indicator has fallen over the past year, even as GDP growth continued at a steady pace of nearly 1% in the second quarter. Much of the weakness can be traced to a steepening of the yield curve component as the Federal Reserve raised short-term rates from their record lows while bond yields eased. The Conference Board, which maintains the US index, has modified this variable so that a negative reading is only recorded when short-term rates actually exceed long-term; as a result, the overall leading index was revised up substantially over the past year. Statistics Canada uses the money supply, not the yield curve, in its index.

Labour Markets

Employment levelled off in July after solid growth in the second quarter. The labour force grew slightly, although its year-over-year increase remained below 1%. This nudged unemployment up to 6.8% from its 30-year low in June.

While jobs overall were unchanged, there was a sharp shift between goods and services. Employment in goods fell 1%, with losses everywhere but on the farm. Manufacturing was especially weak, falling almost 5% below July 2004, while construction gave back most of its gains the month before. Services picked up the slack, led by trade and transportation.

Jobs in Ontario fell by 20,000 in July, pushing annual growth down to 1%. This shifted the line between regions with above- and below-average year-over-year growth from the Ottawa River to the Manitoba border. BC continued to lead growth, although business services paused in July. Employment picked up slightly on the prairies, notably trade after booming retail sales in the first half. Quebec was buoyed by services, which offset a steep drop in factory jobs.

Leading indicators

The leading index rose by 0.3% in June, the same increase as in May. Domestic demand continued to strengthen, boosted by an upturn in housing in June. Six of the ten components advanced, one less than in May as manufacturing lost some of its recent strength. Overall, three components fell while one was unchanged. The US leading indicator continued to slump, although their economy remained strong. Without the drop in the US index, Canada’s leading indicator would have risen 0.6%.

After turning up in May for the first time in almost a year, the housing index jumped 2.6% in June, its largest gain in a year. Condominium construction led the advance in May: in fact, it was the only area of starts which were ahead of last year’s pace. Nearly one-third of all condos were being built in Vancouver. Western Canada also accounted for the record number of existing home sales in June.

Despite the burst of new construction, housing prices remained well under control, a reflection of the balance between supply and demand. Costs were contained by the price of land, which has only inched up 4.2% compared with the 1989 boom when it rose 26.2%. Moreover, wages in construction have risen less than all other industries over the last ten years. And the price of materials remains weak, notably lumber where restrictions on exports have directed supplies to the domestic market.

The growth of new orders for manufacturing was interrupted by a slump for transportation equipment, especially the volatile aerospace section. Excluding this industry, new orders remained close to the high set in January. Another measure of the solid underlying trend in manufacturing is that their demand for labour held onto the gain mode in May. Moreover, capacity utilization in the first quarter was at its highest level since 1987, with several investment-related industries either setting new records (notably machinery and non-metallic minerals) or approaching them (lumber and fabricated metal). Employment in business services resumed its growth after a pause in May.

The stock market was lifted by energy and consumer goods.

The US leading indicator slumped anew with a 0.3% drop. It has fallen steadily over the past year, largely because of the rising yield curve. Users should be aware that the US Conference Board in July revise its calculation of the yield curve, to correct for the exaggerated impact it has had on the overall US index.

Output

Real GDP in May matched its 0.3% April gain, as the economy returned to the growth path set late in 2004 before a stall in February and March. Mining led these increases, contributing nearly one-quarter of all output growth in the last two months despite representing only 3.6% of GDP. The increase in mining was led by diamonds, potash, uranium and exploration for oil and gas. Non-residential building also continued to strengthen for the sixth straight month, while engineering rose for the seventh in a row.

The upturn in mining output followed nearly a year in which output languished despite soaring prices. The delay reflects a number of factors, including fires that disrupted oilsands output, strikes in mining, and poor weather for oil drilling. Not all these problems were overcome in May: the oilsands will not return to full production until September, while a strike in the iron ore industry was not settled until the end of the month. The ongoing resolution of these problems and the coming on stream of the Voisey Bay nickel project this winter point to continued strong gains in mining in the second half of this year. At 84.7% capacity use early in 2005, mining has the most unused capacity of any sector to absorb a sharp increase in output.

A slight downward trend in natural gas output also has hampered the mining sector in the past year. While oil output rose thanks to unconventional sources like the oilsands, natural gas output peaked in 2003 despite continued high prices. Growing demand has been met by an upturn in imports, and sparked the search for unconventional sources, notably coal-based methane.

Manufacturing output continued to recover gradually from a small retreat in the first quarter. Resource-based industries led the way, notably metals. Auto assemblies snapped out of a 3-month skid, while ICT production rose slowly. Textiles and clothing continued to shrink rapidly.

Services expanded 0.2%, after a sharp gain in April when strikes in education were resolved. Professional services led growth, notably in Alberta and BC where jobs in this industry rose 11% and 19% respectively from last spring. Real estate activity continued to thrive due to a healthy housing market. Transportation was buoyed by a sixth straight increase in air travel, which has surpassed its pre-9/11 levels and is now just shy of its all-time peak. Consumer spending was restrained after a strong start for the year.

Household Demand

The rapid growth of retail sales so far this year was interrupted by a 1.2% drop in volume in May. However, virtually all of the drop originated in slower auto sales. This weakness was reversed in June, even before North American auto firms began to extend employee discounts to all customers.

Demand for other durable goods was mixed, with gains for computers offset by losses for furniture, appliances and home entertainment. Higher prices and a cool spring dampened clothing demand. But lower gasoline prices helped send consumption of non-durable goods soaring. Factoring in electricity and other non-retail sales, total consumer spending on goods was little changed in the last two months.

Housing starts rose 7% in June to an annual rate of 237,200 units, their highest level to date in 2005. All of the increase was in multiple units, helped by the strength of the condominium market in Vancouver and Toronto. Ground-breaking on single-family homes was steady at about 100,000 units, despite flooding that dampened starts in Alberta. New home sales in June slowed for a fifth straight month, helping to ease the upward pressure on new home prices. Existing home sales rose for a fifth month in a row, driven by gains in Alberta and BC.

Merchandise trade

A big gain in imports and stagnant exports squeezed the trade surplus in May. A drop in our energy surplus was temporary, as oil prices recovered in the summer and disruptions to oilsands and offshore output were resolved. Imports rose 2.3%, fuelled by a jump in oil needed by refineries. Together with a lower exchange rate in the spring, this helped to push up import prices in May. There is no end in sight to the voracious demand of firms in Canada for machinery and equipment.

Machinery and equipment was the steadiest source of import growth, rising for a sixth consecutive month to bring the total increase since last November to nearly 10%. Excavating and drilling machinery led the gain, offsetting a temporary drop for aircraft. The construction boom in Canada also pulled in 10% more imports of forestry products such as wood siding, floors and doors. Another area where Canada runs a large surplus but imports are rising is natural gas. Imports so far this year are up 47% as Canadian supplies have stopped growing over the last two years. This has sparked growing exploration and development of coal-based methane in Alberta.

Demand for consumer imports continued to climb, notably pharmaceuticals and reading material. Autos were the main source of weakness in import demand, especially parts.

Exports edged down 0.5% after back-to-back increases. Autos and consumer goods were the only areas to expand. The temporary drop in oil prices dampened energy exports. Lower prices also lowered earnings from metal and wood products. Machinery and equipment was slowed by a drop in the volatile aircraft category. Agriculture was boosted by continued strong gains for processed meat, which has risen rapidly since the US closed its border to our live cattle.

Prices

The CPI rose 0.2% between May and June, reversing a similar drop in May and leaving the annual inflation rate little changed at 1.7%. Most of the upturn in prices originated in gasoline, which rebounded from a dip in May.

Elsewhere, prices for durable and semi-durable goods fell and are below their levels in June 2004. Durables were curbed by discounts for auto purchases (which intensified in July) and the usual declines for computers and electronics. Clothing helped pull down the cost of semi-durables. Food prices rose, even before the re-opening of the US border to our cattle diverted supplies to their market. And house prices continued to rise at about a 5% annual rate. Air transport rose on a monthly basis, but is little changed from last year despite rising fuel costs and fewer airlines.

Commodity prices continued to trend up in July, although most of July’s increase was confined to energy. Crude oil prices again broke $60 (US) a barrel, while natural gas hit a new high for the year when a heat wave in much of the US and Southern Ontario sent demand for electricity to record levels. Metals prices remained high, with copper eclipsing its previous peak set in 1988. Wheat prices could not add to last month’s gain, despite intense droughts in much of Europe and Australia. Cattle prices recovered after exports to the US resumed. Prices for non-energy manufactured goods dipped in May and June when the exchange recovered from a small slide in the spring.

Financial markets

Interest rates in Canada were stable, and remained lower than at the start of the year despite a ninth straight increase in the US federal funds rate. Still, the loonie edged up against the US greenback for a third straight month.

With interest rates low, investors shifted out of money market funds for a fourth straight month in June. The stock market was one destination for these funds, with the Toronto market up 6% to bring its total increase since April to nearly 10%. Metals and energy continued to spearhead the rally, with double-digit gains for a second straight month.

Regional Economies

Western Canada held its lead over the rest of the country. While retail sales tumbled in the rest of Canada, they gained nearly another percentage point in the Prairies and remained essentially unchanged in British Columbia. While floods helped drive housing starts down from their high for the year in May, the number of existing houses sold broke another record. British Columbia and the Prairies accounted for almost 40% of sales of existing units at the national level in the first half of the year. Non-residential building permits have nearly doubled compared with last year.

Alberta maintained the same healthy advance in shipments as it did in April, and it has been responsible for much of the national growth since December. It also continued to reap most of the revenues from Canadian export growth. In the second quarter, it reinforced its first-quarter gains with further advances in energy, capital goods and processed meat.

In British Columbia, shipments were bolstered by domestic demand after a two-month decline. The upswing was led by building materials and machinery, with exports trailing due to weakness in forest products. The downturn in pulp shipments to China continued. Over the last few years, China has imported almost as much waste paper and cardboard (mostly from the US) as pulp, which has hurt Canadian pulp exports. China has invested heavily in new paper recycling technologies.

In contrast to Western Canada, shipments resumed their downward trend in the central part of the country. They were off 0.7% in Ontario. Despite an advance in April, they have dropped 5% since January. This reflects the weakness in Ontario’s exports, the only region to have posted a decrease so far this year compared with last year. The slump is confined to the paper and automotive sectors, but these are key areas: while they account for only three of the four commodities that have fallen among the top 25 exports, they represent 40% of the province’s total exports.

In the automotive sector, exports of small cars were down the most (20% on an annualized basis) from 2004, compared with 5% for larger vehicles. Even though small cars make up just 20% of auto exports (compared with nearly 50% 15 years ago), they have accounted for almost half of the decline in 2005. The construction of a new Toyota plant will pump new life into small car output. Sales of many larger models in the US have been supported by increasingly attractive discounts by North American manufacturers, including rebates on the price of gasoline.

Domestic demand in Ontario was split between a sharp decrease in retail sales, which resumed the downward trend that started last fall, and buoyancy in investment. Housing starts jumped to their highest level since the February 2003 peak, a mark surpassed only once before in the early 1970s. Construction forged ahead despite more vacant units. Growth in non-residential building permits remained below the national average, although they are up more than 20% so far this year compared with 2004.

The economy slowed in Quebec. Shipments were down, largely because of the volatile aircraft industry. Exports continued upward climb. But domestic demand fell sharply: retail sales slumped (-1.3%) as employment has slipped by 0.5% since January (the Atlantic provinces are the only other region where employment has declined). And non-residential building permits fell 11% this year with the completion of a number of major projects started over the past two years.

International economies

In the United States, real GDP rose 0.8% in the second quarter, essentially matching first-quarter growth. Business investment and household spending (especially housing and autos) continued to grow rapidly, while the trade balance improved as exports rose while import volume fell (although higher oil prices pushed up the nominal bill for imports). Only a drop in inventories inhibited growth.

There was no sign of a slowdown in June. House sales set another record, retail sales growth was the fastest so far this year, while industrial output rose the most since February 2004. There was some reduction in the trade and budget deficits.

Existing home sales rose 3% in June to their highest level on record. Surging demand boosted house prices 15% from a year-ago, the most in 25 years. Brisk new home sales kept housing starts at two million units for a third straight month, 10% ahead of last year. The backlog of units authorized but not yet started was up 19% from last June, suggesting shortages were a growing problem in construction.

Retail sales jumped 1.7%, and their 10% increase from last June was the largest so far this year. Auto sales led the way, as GM’s employee discount for everyone broke sales records. Non-auto sales posted a healthy 0.7% advance. Gasoline consumption jumped 2%, overcoming a small price hike. Warm temperatures sent clothing sales up 1%, while housing-related items remained in strong demand.

Unseasonable warmth sent electricity generation soaring 7% in June, leading the 0.9% gain in industrial production. Temperatures broke more records in July. Manufacturers also posted a solid 0.4% gain, matching May’s increase. Auto assemblies recovered in both months, while business equipment continued to expand steadily. New orders for capital goods continued to strengthen in June.

The ‘twin’ deficits of the US also improved. The monthly trade deficit fell $1.6 billion to $55.3 billion in May, although part of the drop reflected a temporary dip in oil prices. And the federal government’s deficit in the first nine moths of fiscal 2005 was 24% (or $77 billion) below 2004, thanks to strong revenue growth. Personal tax revenue was up 16% (helped by payments on capital gains) and corporate taxes 41%, partly as last year’s accelerated depreciation allowances expired. Meanwhile, both defense and non-defense spending rose 7%.

Industrial production fell in the euro-zone in May due to declines in manufacturing. New orders gave back all of their increase of the month before, with only chemicals and electronics posting slight gains. Consumer spending rebounded in May and the unemployment rate fell to 8.8%. The annual rate of inflation rose to 2.1% in June, boosted by housing, alcohol, tobacco and transport.

Real GDP in Britain grew 0.4% in the second quarter, unchanged from its first-quarter pace. At 1.7%, this was the slowest annual increase in 12 years. Manufacturing output continued its downward spiral, falling 0.7% after a 0.9% contraction to start the year. The services sector, which has sustained growth in recent years, decelerated to 0.6% from 0.7% in the first quarter. Consumer spending picked up slightly in May even as inflation inched upwards.

German output fell in May, after mild gains in the previous two months. New orders rebounded, however, buoyed by strengthening foreign demand in the wake of sustained weakness in the euro. Consumer spending rose for the third time this year.

Industrial production in France recovered slightly in May, posting its first monthly gain since January. New orders surged, more than recouping the previous month’s decline. Stronger foreign demand boosted exports, while consumers began to open their wallets.

Japan’s export volumes rose in June for the first time in three months, as US demand for autos and telecommunications equipment surged. Demand from Asia continued to fall, albeit at a slower rate, while exports to Europe dropped sharply, reflecting their weaker pace of growth. Imports remained high, boosted by rising oil prices, leading to a further narrowing of the trade surplus.

China’s economy grew 9.5% year over year in the second quarter, led by robust investment and exports. Business investment picked up after a slowdown in late 2004, gaining 27% in the first half of the year, although still below its peak rates of early last year. The government reined in investment with a combination of land management and tax policies, lending limits on banks and interest rate hikes. Exports rose 30% in the first half compared to last year, while imports continued to decelerate as manufacturers were increasingly able to produce equipment once sourced from overseas.

Output in Thailand fell 0.6% in the first quarter of the year, its first contraction in four years, as drought dampened food output and last December’s tsunami kept tourists at bay. GDP had risen 1.5% in the fourth quarter of 2004. High oil prices led to the biggest monthly trade deficit in nine years in April, when the country’s fuel bill jumped 63%.

South Korea’s economy grew 1.2% in the second quarter, after a 0.4% rise in the first, as consumer spending picked up amid low interest rates and tax cuts. Business investment was also strong, while exports fell for the first time in four years when foreign demand for technology products weakened.

Note

* Based on data available on August 5; all data references are in current dollars unless otherwise stated.