11-010-XIB
Canadian Economic Observer
September 2007

Summary table - key indicators

Overview*

Second-quarter real GDP growth remained strong at 0.8%, on the heels of a 1.0% gain in the first. After a slowdown in the second half of 2006, year-over-year growth has recovered to 2.6%.

Domestic demand remained the driving force of growth. Household spending grew steadily, with housing so far this year pulling out of a slowdown in 2006 (and in marked contrast with the US housing market). Business investment rebounded from a pause in the first quarter, encouraged by the provision of accelerated depreciation in the spring budget and sharply lower import prices as the exchange rate posted one of its largest-ever quarterly increases. Exports continued to grow slowly, and the nominal trade balance received a further boost from lower import prices.

Despite the rebound in quarterly investment spending, the year-over-year growth of business investment has slowed from years of double-digit gains to just 5%. Much of this deceleration originated in large cutbacks for natural gas drilling in response to sharply lower prices. With corporate profits continuing to expand, this kept the financial surplus of firms near record levels, an ample cushion against the turmoil in financial markets in August. The first indications are that the real economy held up well in August, with jobs and consumer confidence posting gains in Canada while auto sales rebounded.

Labour markets

Employment rose steadily in August, with the 0.1% increase matching July’s gain. The survey week coincided with the upheaval in global financial markets, ending with the cut in the US discount rate on August 17. Most of the increase was in part-time positions. With a matching increase in the labour force, mostly adult women, the unemployment rate was unchanged at 6.0%.

Goods-producing industries led the advance, led by construction in BC and Quebec. Manufacturing held on to most of their recovery the month before, with increases in Quebec offsetting losses in Ontario. Still, overall employment in Ontario was boosted by a large recovery in jobs in education. Services overall were little changed, as gains in Ontario and BC offset losses in Quebec and Alberta. The labour dispute in BC’s forestry industry and Vancouver’s municipal services that began late in July had little impact on its unemployment (strikers are counted as still holding a job) but lowered hours worked in BC by 0.7%.  The unemployment rate was little changed in most provinces.

Leading Indicators

The composite leading index advanced 0.4% in July, after an upward-revised gain of 0.3% in June. Six of the ten components expanded, one more than in June, while two were unchanged and two declined. Household spending remained the main source of growth, while manufacturing continued to lag.

Consumer spending on the two durable goods components posted their largest gains in a year. Furniture and appliance sales received a boost from continued strong existing home sales over the summer and a rebound in housing starts. Spending on other durable goods continued to strengthen, underpinned by strong labour market conditions and lower prices for imported consumer goods.

Business spending remained a positive force in domestic spending. Business services drove the growth of services employment. The rebound of business investment was reflected in non-residential building permits and the volume of machinery and equipment imports, both of which hit record highs in the second quarter.

Manufacturing remained the weakest sector of the economy. Orders for durable goods and the ratio of shipments to inventories both trended down, although the unsmoothed versions turned up. The slack in manufacturing reflects weak US demand. The US leading indicator was unchanged last month, and has not risen in five months. While this understates the underlying strength of the US economy, this correctly reflects the underlying trend of our exports to the US at a time of a rising exchange rate.

Output

Real output grew by 0.2% in June on top of May’s 0.3% gain. A rebound in mining output accompanied steady growth in construction and most services.

Mining output jumped nearly 3% after three straight declines. This hike reflected the end of labour disputes in iron ore and a bottoming out of the recent slump in natural gas. With these negatives removed, strong growth in other mining industries such as the oilsands, potash and metals became more visible.

Construction activity also returned to the forefront of growth that it occupied through most of 2007. Non-residential building has taken off, up 0.7% in June, led by growth in Alberta and BC. Meanwhile, housing grew steadily.

Demand for services rose 0.2% after a 0.5% gain in May. While retail sales slipped, consumer spending rose strongly for other services such as gambling and restaurants. Financial and business services all continued to post solid gains. The goods-handling sectors (wholesale and transportation) fell, in line with lower manufacturing output and resource exports.

Manufacturing production dipped 0.4%, its third straight slow month after a strong start to the year. Sharp cutbacks in the auto industry led the second-quarter slowdown, triggering cuts in feeder industries such as rubber and steel. Most other industries remained on a positive track. Output of ICT goods rose sharply for the fourth time in five months, while aerospace and chemicals remained buoyant. Output also turned up in the first half of the year in textiles, clothing and furniture (after years of heavy losses totalling over 30% for textiles and clothing and 10% for furniture).

Household demand

Retail sales volume dipped 0.6% in June, giving back one-quarter of its surge in May. The 2.6% quarterly growth of sales was the most since late 2001. While outlays for durable goods softened, lower prices kept demand growing for other goods.

Most of the drop in durable goods originated in auto sales, which slowed in June and continued to decelerate in July. Spending on other durable goods remained steady.

Consumption of clothing and non-durable goods added to their gains in May. After a weak April, retailers slashed clothing prices by over 1% in both May and June, keeping demand growing for a sixth straight quarter. Lower gas prices gave a lift to non-durables, while food purchases were undeterred by higher prices.

The new housing market softened in July. Sales fell after gaining throughout the spring. However, housing starts receded even faster, preventing an increase in the backlog of unsold units. Sales of existing homes continued to strengthen in July. Both prices and sales volume continued to rise at nearly a double-digit rate from last year’s pace.

Merchandise trade

The current account surplus rose to $8.4 billion in the second quarter, its largest since early 2006. The merchandise trade surplus was boosted by a sharp drop in the cost of imports. The shortfall for services was trimmed by a dip in the travel deficit, as US visitors spent more here while Canadians spent less in the US despite the rising dollar.

The appreciation of the Canadian dollar continued to dampen nominal cross-border trade flows in June. Exports fell 1%, almost all due to a drop in prices. Imports edged up 0.6%, as a 2.5% drop in prices masked a large surge in volume.

Import prices fell about 3% for most goods, except energy where prices rose. Firms rushed to take advantage of these declines, especially machinery and equipment where the volume of imports jumped the most (4.3%) in over three years. Import volumes of autos and industrial goods also grew strongly, although some of these gains only offset declines in recent months. Imports of consumer goods hit a record high volume, led by clothing where the cost of imports has fallen nearly 10% since January. The price of imported fruits and vegetables also has declined nearly 10% since the winter.

The weakness in exports largely originated in machinery and equipment. Aircraft shipments tumbled from their five-year high set in May, accounting for virtually all of the decline. Lower prices dampened export earnings from autos and most resource products. Not all of the declines for resources were related to the exchange rate, as the export price of oil and metals hit their lowest level of the year. This offset continued strength in inorganic chemicals, notably uranium, which jumped 50% to $714 million.

Prices

Consumer prices were unchanged for a second straight month, leaving the annual inflation rate steady at 2.2%. The dichotomy continued to grow between goods and services: the price of goods (excluding food) fell by 0.3% in the past year, as the rising dollar dampened the cost of imports. But the price of services (most of which are non-tradeable) jumped 3.7%, fuelled by housing.

The cost of goods fell again between June and July. Autos led the decline, as slow sales sparked increased discounting. Electronic goods posted further drops, while gasoline prices continued to moderate. Some of these declines were offset by a sharp upturn in clothing prices, after two months of heavy discounting.

Food prices continued to moderate to an annual rate of 2.8%, after shooting above 4% earlier this year. Most of the slowdown originated in fruits and vegetables. Higher grain prices on commodity markets has not fed through to consumer prices for bread and cereal products.

Shelter led the increase in services, rising 5.0% in the past year. Double-digit increases in the cost of housing has spread from Alberta in 2006 to BC and Saskatchewan this year. But the price of services excluding shelter also rose 3.3% from July 2006. Notable increases occurred for travel, personal and health care services as well as communications.

Farm prices continued to rise, with wheat hitting a record high after Canada said dry, hot weather would reduce its crop by 20%. Together with rising prices for corn used as a bio-fuel, this raised farm income from crops by over 20% in the past year. Other farm income showed no growth.

Commodity prices slid for energy and metals in August. Energy was depressed by natural gas, where inventories remain high as the summer cooling season ended. Metal prices fell sharply, led by nickel. Some selling of energy and metals was reported for hedge funds, which had to recoup losses in other financial investments in August.

Industrial prices fell 0.7% in July, their third straight decline. As a result, prices for manufactured goods posted their first year-over-year decline since August 2005. About half the monthly retreat reflected the impact of a stronger Canada/US exchange rate. There were also significant declines for metals, uranium and fertilizer.

Financial markets

Financial markets were seized by a near-panic in August, akin to the LTCM meltdown in 1998. The crisis began with an upsurge in the rate banks charge each other for over-night lending in Europe and the US, following mounting concerns about losses in the US subprime mortgage market. Central banks countered this increase in rates, but the ensuing flight to quality (especially from asset-backed commercial paper) drove up the cost of borrowing for some firms while reducing rates on government debt.

Asset-backed commercial paper (ABCP) was the Canadian market most affected by the drying-up of investment, as its rate rose about a full point. ABCP is about one-third of Canada’s commercial paper.

The turmoil in the global financial system led to a third straight small decline in the Toronto stock market in August. The 1.5% drop was broad-based, including most sub-indexes except financial stocks themselves. Mining led the retreat, giving back about half of its recent increases.

Foreign direct investment in Canada totalled $17 billion in the second quarter, mostly acquisitions. Europeans led this increase, which remained focused on the energy and metals sectors for a tenth straight quarter.

Regional economies

Most sectors and regions slowed at the same time in June and July after a brisk start to spring. Household demand took a breather in Quebec after leading the country in April and May. Retail sales dropped by 3.4% in June after rising 1.2% and 4.7%. Housing starts declined slightly in July from their two-year peak posted the month before. However existing home sales set a second straight monthly record. The inventory of unsold new single-family homes barely moved from their 10-year low. The trend in household demand should remain strong this year as a result of the pay equity settlement reached for government employees. In addition to the $1.9 billion paid this spring, another $825 million will be gradually added to the annual salary base.  

Retail sales held steady in British Columbia for the first time this year, with a 1.3% rise in May. Shipments dropped because of the sharper drop in exports. The persistent weakness of exports to the US was accompanied by a steep decline for Japan, where mineral exports fell sharply. The forestry sector remained weak in June, with paper exports down sharply, on the heels of a drop for lumber.

Although manufacturing weakened everywhere, Ontario was hit the hardest. This led to a decline in second-quarter shipments, the only one in the country. The automotive sector continued to slow as a result of the drop in exports, which even affected the new domestic manufacturers. Since these new auto manufacturers are turning out models that are in high demand in the US, the record rise in the dollar likely played a role in lower exports, since imports from Japan rose to meet strong sales in the US. Elsewhere in manufacturing, metals continued to post gains, as did electrical and leather products. 

In the Prairies, shipments lost some of their momentum from May due to a slowdown in capital goods. Building permits posted a new record in June. Household demand remained robust, with retail sales managing to add to their 2.6% jump in May.

International economies

The United States grew a steady 1% in the second quarter, as gains in business investment and exports offset a slowdown in consumer spending. Growth continued early in the summer as industrial production, retail sales and international trade all posted gains. The housing market was sluggish in July heading into the August financial turmoil.

Industrial production was up 0.3% in July. Autos and business equipment, notably aircraft, drove the gain. The 0.9% increase in business equipment was the biggest since March and marked its sixth consecutive rise. Autos and aircraft also led the 6% gain in new orders of durable goods.

The US trade deficit fell to $58.1 billion in June, its lowest since February. Exports outpaced imports, with industrial materials, such as energy, metal and chemical products pushing forward export values.

Retail sales rose 0.3% in July, boasting widespread gains. Declines were confined to auto sales, and gasoline sales as prices dipped. Activity in department stores as well as clothing, electronics and food and drink establishments picked up sharply. These advances combined with slight gains in furniture and building material sales offer a picture of business as usual spending for the month.

In the housing market, building permits dropped 2.8% in July while housing starts were down nearly 6%. This was in contrast to stable existing home sales and a 2.8% rise in new home sales. Consumer confidence surveys for August indicated that the boost in confidence in July had been deflated somewhat but the declines were moderate. Moreover, the drop in confidence was concentrated in the first two weeks of August when financial markets buckled and did not accelerate later in the month.

Real GDP grew by 0.3% in the euro-zone in the second quarter, less than half its first-quarter gain, and only a third of its fourth-quarter pace. While exports grew steadily and household demand rebounded, investment fell abruptly after a year of solid growth.

Industrial production fell slightly in June as demand waned for both goods and energy. New orders picked up, led by a surge in transport equipment. Consumer demand was tepid, following two months of outright decline. The external trade surplus widened in June, despite the rising value of the euro which prompted an interest rate hike in July. The energy deficit narrowed while the surplus for machinery and vehicle grew due to exports to Russia, India, China and South Korea. The unemployment rate was stable at 6.9%, while the annual rate of inflation eased to 1.8%.

The pace of growth slowed to 0.3% in Germany. Industrial production fell in June after a strong gain in May. New orders rose for the second straight month, indicating that the rising euro was having little effect on foreign demand. Domestic demand recovered slightly in June, following a sharp decline in retail sales in May. The unemployment rate was stable at 6.4% in July.

Real GDP rose 0.3% in France, down slightly from its 0.5% hike in the first quarter.  Industrial production lost all of its previous month’s gain in June, although new orders continued to advance, adding to their rise in May. Consumer demand was weak in the second quarter, despite a steady drop in the unemployment rate to 8.6% in July.

Real GDP in Britain rose 0.8%, essentially matching its gains in the previous three quarters. Industrial production slowed in June after a surge in May. Both exports and imports eased as the sterling remained strong and interest rates high. Consumer demand was stagnant, while inflation fell to 1.7% in July from 2.4% the month before, as food prices eased.

The Japanese economy grew 0.1% in the second quarter, dampened by weak exports and residential construction. Despite a 12% rise in exports in July, the trade surplus narrowed for the first time in nine months as weakness in the yen and higher crude oil prices boosted imports 17%.

Manufacturing output decelerated in China in July as the government raised interest rates for the third time in six months and reduced export incentives to cool the economy.  Inflation soared to its highest rate in a decade, hitting 5.6%. Meat prices soared 45.2% as millions of pigs died from an illness. Non-food inflation remained low, however, at 0.9%.

Note

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