11-010-XIB
Canadian Economic Observer
September 2003

Summary Table - Key Indicators

Overview*

The dominant theme of the second quarter was the rise in the Canadian dollar, the sharpest quarterly exchange rate movement in over half a century. This had a pervasive impact, lowering prices and the nominal value of transactions in many sectors of the economy. This contributed to the lowering of the current account surplus from $6.9 billion to $5.1 billion. Export receipts fell 4.8% while imports sipped 4.5%: all of this reflected lower prices, however, as the volume of trade flows actually increased slightly.

Household spending remained the engine of growth in the second quarter, and both retail sales and housing demand accelerated further as summer began. While job growth slowed, lower consumer prices (notably for imported goods) helped to sustain real disposable incomes. Households continued to borrow heavily, with mortgage debt rising a record $28.7 billion in the second quarter.

The volume of business investment edged up in the first two quarters of 2003, consistent with the firming of investment intentions at mid-year and ending over a year of steady declines. Firms were encouraged to invest by sharply lower prices for imported machinery and equipment, which allowed them to acquire more even as they spent less in nominal terms. Corporate belt-tightening reflected a drop in profits, the first since 2001, largely because of falling energy prices and weak manufacturing demand. This was partly offset by an increase of over $20 billion in funds raised in both stock and bond markets, which outweighed a paydown of about $20 billion in short-term debt.

The government sector lent significantly less to financial markets in the second quarter, largely due to the first dip in revenues since late 2001. As well, as announced in the budget there was a supplementary one-time transfer of $4 billion from the federal government to provincial governments. As a result, the federal government posted its first quarterly deficit in four years, while provinces swung to their first surplus since early 2001.

Besides the exchange rate, several transitory factors dampened second-quarter output. The SARS outbreak and the Iraq war depressed the travel industry, with visitors to Canada falling 14% although a slow recovery began in June. The mad cow crisis crippled the beef industry, virtually closing the border to beef exports and sending livestock prices plunging 63%. But at the national level, this was largely offset by higher demand from consumers (which helped grocery sales recoup virtually all of their record drop in May) and gains for seafood and chicken producers. A strike in nickel mining that began in June had a larger impact, shaving nearly $750 million (or 0.1%) off GDP, over three times the direct effect of mad cow disease on beef production. The Toronto stock market discounted these temporary setbacks, advancing again in August to bring its cumulative increase to 17% since the rally began in April.

With the dip in GDP in Canada, a majority of the G7 nations had lower output in the second quarter. Germany, Italy and France also posted small declines: unlike Canada, however, GDP in these nations has been virtually unchanged for a year. The US led the G7 with 0.8% growth, and household demand and industrial production continued to accelerate in July. Meanwhile, Japan posted the second-fastest growth, while its stock market was buoyed by improved profitability.

Labour Markets

The job market remained soft, as employment edged down 0.1% in August, its fourth such decrease in the last five months. The survey week coincided with the blackout in Ontario, where hours worked fell a record 5.9%. Over 1.3 million workers in Ontario missed some work because of the blackout. With the labour force continuing to expand, the national unemployment rate hit 8.0% for the first time since December 2001. The increase in unemployment was confined to Quebec and Nova Scotia, where most of the growth of the labour force originated.

Job losses were widespread in services, especially business services in Ontario. Manufacturing also retrenched, notably in Quebec. Construction remained a pillar of strength in most areas, led by Alberta, as business investment began to reinforce the strength in housing demand.

Leading indicators

The composite leading index posted its largest increase in a year with a 0.4% gain in July after a 0.3% advance in June. The improved prospects for growth reflect continued strength in household spending and an upturn in business investment. Even the export sector picked-up, after being the source of much of the slowdown so far this year, as the US leading index rose while the exchange rate backed off from its recent highs. The one negative component was due to rising inventories in the manufacturing sector.

All of the indicators related to household demand improved. Housing recorded its third straight increase, as starts of multiple units surged. The strength in housing spilled over into an acceleration of spending on furniture and appliances. Durable goods sales posted their first back-to-back gain since early 2002.

The stock market picked up steam in July, lifting growth over the last four months to its strongest since August 2000. All the major components advanced, which will encourage firms to continue to issue equity to raise funds.

In manufacturing, rising inventories in export-based industries where sales slumped raised the overall ratio of shipments to inventories for the fourth straight month, led by lumber and industrial goods and most recently by information technology. These industries also led the cuts to production and the average workweek in May.

The US leading indicator also recorded its first consecutive increases in over a year. Growth extended beyond the financial markets, with residential building permits up for the first time in four months.

Output

The volume of GDP rose 0.1% in June after an upwardly revised gain of 0.2% in May. Weak export demand for manufactured goods continued to restrain growth. However, household demand remained robust while business spending continued to improve.

Growth was buttressed by widespread gains in services. Finance and real estate expanded rapidly for the third straight month, buoyed by strong demand in both the stock and housing market. Business and telecom services also grew steadily through the second quarter. Travel-related industries (from travel to food and accommodation) all began to slowly recover from the twin effects of the SARS outbreak and the Iraq war. Education grew as universities began to gear up for the arrival for the ‘double-cohort’ of graduates from Ontario’s secondary schools.

Manufacturers cut output another 1.1% in June, completing their largest quarterly decline since the September 11 attacks. Autos assemblies retrenched anew, after a brief upturn in the previous three months. Meanwhile, aerospace, ICT and steel all continued a long sequence of monthly cuts. Smelting and refining operations fell 12% due to the Inco strike: together with the 23% drop in metal mining, the direct effect of the strike was to reduce GDP by $748 million. Beef production continued to tumble, although nearly half the recent losses were offset by gains for seafood and chicken processing. Elsewhere, utilities saw demand drop 2% as hot summer weather was late to arrive.

Household Demand

Retail sales volume rose by 0.5% in June, salvaging a quarterly gain of similar magnitude. Widespread price discounting by retailers continued to spur consumer spending. This was particularly true for clothing, where sales surged over 2% after prices tumbled. As well, lower prices helped durable goods hold on to most of their 2% advance the month before. While the stimulus of discounts waned for auto sales, they sparked solid gains for furniture, appliances and electronic goods. Elsewhere, food consumption recovered most of its record drop the month before, as the shock of a single case of BSE wore off and consumers took advantage of lower prices.

Housing starts soared to an annual rate of 223,500 units in July, their second-highest level since April 1990. Both single-family and multiple-dwelling starts strengthened for the second month in a row. House sales remained robust, with demand for existing homes rising at a double-digit rate in July on the heels of gains in the second quarter. The surge in sales accompanied a sharp increase in new listings of homes for sale.

Merchandise trade

The rise in the exchange rate continued to dampen the value of trade flows across the Canadian border in June. Exports fell 1.3%, all due to prices, while imports retreated 2.2%. As a result, the trade surplus continued to subside, to $3.6 billion in June. In the first half of the year, the surplus in goods totalled $26.2 billion, about 10% lower than the year before.

The largest contributor to the loss of exports was slumping demand for aircraft, which plunged 20% to a new low for the year due to the deepening slump in air travel in the second quarter. The auto sector also continued to slow, although this mostly reflected exchange rate changes as the volume of shipments held up. A strike in the nickel industry cut exports by nearly 40%. Finally, beef shipments tumbled by nearly $300 million (to virtually nothing) as 34 countries closed their borders to Canadian beef. The US ban on imports was partly lifted in August.

A third straight drop in imports originated largely in autos and consumer goods, despite the pick-up in retail sales in Canada in the last two months. Machinery and equipment rebounded from its slump so far this year, notably for industrial and drilling machinery. However, demand for ICT equipment and aircraft remained weak. Elsewhere, higher oil prices boosted our bill for energy imports.

Prices

The price index for GDP fell 0.4% in the second quarter, largely due to a 5.3% drop in the price of exports. Falling energy prices and the rising exchange rate drove this decrease. Meanwhile, spenders in Canada paid 0.3% less for their purchases, aided by a 5.8% drop in import prices. Consumer goods and business machinery and equipment were the primary beneficiaries of these declines. Housing was the only sector where prices rose significantly.

Consumer prices in July edged up 0.1% for the second straight month after three consecutive declines in the spring. The restraint in prices over the last five months has more than halved the annual rate of inflation, from 4.6% to a 12-month low of 2.2%.

The cost of most goods continued to moderate, as the ongoing dampening effect of the exchange rate was reinforced by price cuts for autos and beef. Auto prices fell nearly 1%, as dealers offered additional incentives after a 1.5% drop in June. The cost of buying a vehicle reached its lowest level since October 1997. Beef prices tumbled 5%, their largest monthly drop in nearly three decades as the closing of the border for exports increased supplies for the domestic market, especially in Alberta. Weak demand also checked prices in the travel sector.

Energy was the major source of upward pressure on prices, with gasoline rebounding 2% after steep declines in the spring. Services continued to creep up, notably health care and houses.

The drop in the exchange rate in July already showed up in a 1.3% jump in producer prices, mostly for exports. Raw materials prices were pulled down by a 44% tumble in cattle prices, which augurs further declines for consumers after beef prices fell at an accelerating rate in June and July.

Commodity prices rebounded in August from a brief setback the month before. Energy prices led the way, partly due to the disruption the blackout caused to refinery operations. The recent surge in metal prices lost some of its vigor, helped by the resolution of the nickel strike. Fires in the interior BC also boosted lumber markets, at a time of robust housing demand in North America. Wheat prices rose as Europe’s heat wave stunted its crop.

Financial markets

The stock market continued its rally, with a 3% gain in August bringing the total advance to 17% since April and raising the index to its highest level since May 2002 (surpassing the recent performance in New York, Europe and Japan). Growth in Toronto was again led by information technology (other than telecom), up nearly a half since the spring. Energy and metals continued to perform well, as did real estate. Utilities sagged while consumer stocks stalled.

Part of the recent rally in the stock market reflected increased purchases by non-residents. Foreign investors bought nearly $3 billion of stocks in Canada in the second quarter, after a sell-off in the first. They also bought $6.4 billion of bonds, although these were increasingly denominated in currencies other than the Canadian dollar (insulating themselves from exchange rate risk). Meanwhile, investors in Canada continued to shift out of money market funds in July. Interest rates and the dollar were little changed in August.

Regional economy

The outlook for construction in Quebec remained as bright as it has been for more than a year. Housing—the main source of strength last year—continued to boom. Housing starts in July were at their highest level since 1992, while sales of existing homes continued to grow rapidly. Non-residential construction continued to share in this growth; permits jumped again in June, bringing their quarterly value to its highest level since the first quarter of 2001. The growth was led by the institutional sector, although the commercial sector also contributed. Employment in construction has risen by nearly a third since its low of May 2001, accounting for nearly one-fifth of all jobs created last year. Retail sales continued to recover. Manufacturing shipments posted their first rise in four months, led by electronic and computer products.

Unlike Quebec, Ontario saw few signs of improvement in its economy outside of housing. Retail sales failed to follow up on their rise in May, while tourism from abroad remained nearly one-quarter below its level of a year ago. Manufacturing shipments registered their third straight decline, spread among fifteen of the twenty manufacturing industries. The sharpest declines were in industries producing industrial materials, especially primary metals which accounted for about one-fifth of the drop in June when a strike began at Inco. A large majority of industries exporting to the US also saw declines, translating into a drop of nearly 10% compared with June 2002.

Western Canada, and especially British Columbia, participated in the housing boom along with the rest of the country. In other areas, however, the indicators were sluggish. Shipments have declined every month this year and did so again in June, led by the continued slump in forest products with paper (-7%) replacing wood as a source of weakness. The 15% decline in shipments of food products cancelled out renewed strength in industrial materials on the Prairies.

International economies

Household demand in the United States picked up steam in July, fuelled by record demand for housing. Existing home sales (which account for 85% of all sales) rose 5% to an annual rate of 6.12 million, breaking the old record of 5.94 million set last winter. An increase in mortgage rates from their record low in June encouraged households to jump off the fence and buy before rates rose another half point in August. Home-builders responded by starting construction on 1.87 million units, the most in 17 years.

The surge in housing demand continued to buoy retail sales, up 1.4% in July after June’s estimated advance was revised from 0.5% to 0.9%. Housing-related items (such as furniture, appliances and building materials) were up over 8% from last year, the most of any sector. The spurt in housing demand might be short-lived, as building permits dipped in July while re-financing of mortgages slowed markedly when rates continued to rise in August. Consumer confidence sagged slightly, according to the University of Michigan, over concern about rising gasoline prices in August.

The manufacturing sector continued to pull out of its long tailspin, aided by a revival of investment spending and exports. Output rose 0.2% in July, its third consecutive advance. Consumer durable goods were buoyed by rising auto demand. Business equipment posted a third straight gain of 0.4%. New orders for non-defense capital goods jumped 5% over the last two months, led by computers and electronic products.

External demand provided a boost to industrial demand in June. Exports posted their largest increase in three years, up 2.4%. Capital goods led the way. Meanwhile, imports were unchanged, as record demand for autos offset declines for consumer goods. Overall, the trade deficit in goods and services fell $2 billion to $39.5 billion, its third straight decrease.

Second-quarter GDP growth was revised up to 0.8%, surpassing Canada for the first time in 5 years. The upturn of business investment was given a boost by faster write-offs of goods purchased after May 5, which added $18.8 billion to after-tax profits. Falling corporate taxes and a surge in defense spending sent government borrowing past $500 billion (at annual rates) for the first time ever.

Second quarter growth was flat in the euro-zone following negligible growth of 0.1% in real GDP in the first three months of the year and in the final quarter of 2002. A prolonged heatwave in most of the major economies over the summer resulted in power shortages and supply disruptions. Industrial production fell 0.1% in June as demand for capital goods waned. Overseas demand for exports stayed weak as the euro remained high against other currencies. Consumer spending slumped in May, after a rebound the month before, while the unemployment rate was stable at 8.9% in June and the annual rate of inflation eased to 1.9% in July.

The French economy shrank 0.3% in the second quarter, on the heels of downward revised growth of 0.2% in the first quarter. Following a wave of public sector strikes in May and June, consumer spending fell 0.2%. Exports dropped for the second straight quarter, partly in response to the strong euro. Industrial production rebounded in June, however, with its biggest monthly rise since mid-2001, boosted by demand for energy. The annual rate of inflation jumped to 2% in July, while the jobless rate inched up to 9.4% in June.

Germany and Italy both recorded a second consecutive quarter of economic decline. Real GDP in Germany contracted by 0.1% in the second quarter, after a 0.2% drop in the first. Industrial production fell for the fourth straight month in June, as weak domestic demand failed to offset a decline in exports. Weak demand allowed Germany to continue to post the largest external trade surplus in the euro-zone and the lowest annual rate of inflation at 0.8%. Italy’s economy shrank 0.1% as well, matching its previous quarterly decline. Industrial output was flat in June, on the heels of a 1.6% drop the month before. Consumer spending waned as inflation jumped to an annual rate of 2.9% in July.

Japan’s economy grew 0.6% in the second quarter of the year, marking the sixth straight quarter of growth, while deflation slowed to just 0.2%. Consumer spending rose slightly as a rally in the stock market boosted confidence and the jobless rate fell for the first time in four months in June, down to 5.3%. Business investment picked up after demand for information technology products recovered. The Bank of Japan continued in its successful efforts to stall the rise of the yen against the US dollar, spending $75 billion so far this year. Meanwhile, long-term bond yields hit a 30-month high of 1.6%.

Some economies in South-east Asia continued to reel from the effects of SARS and declining foreign demand. Singapore saw its worst quarterly contraction on record in the second quarter as GDP plunged despite a pickup in electronics shipments. In Hong Kong, unemployment continued to mount to a new record of 8.7% in July. Others found ways to sustain growth, 4.4% in Malaysia and 3.8% in Indonesia.

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