11-010-XIB
Canadian Economic Observer
December 2003

Summary Table - Key Indicators

Overview*

A sharp recovery in September allowed real GDP to eke out a 0.3% gain in the third quarter, after a 0.2% dip in the second. The second-quarter dip appears largely due to the substantial effect of the appreciation of the Canadian dollar on our exports. The exchange rate rise also has positive implications for domestic demand that are unravelling more slowly. As well, the second-quarter weakness of the economy was compounded by a number of one-time events, notably the combined impact on travel of the Iraq war and the SARS outbreak in the spring, and the Inco strike in June.

Output began to recover with a 0.6% hike in July just as the US economy accelerated sharply, but was interrupted by the power shortage in Ontario in August, which caused widespread output losses. However, these were quickly recouped in September, and the economy appears poised to resume a strong upward growth path, to judge by a third consecutive solid gain in jobs in November. While the exchange rate has resumed its climb, exports are better positioned to resist its dampening influence due to a stronger US economy and higher commodity prices on world markets. Meanwhile, the drop in import prices due to the rising dollar has helped lower the inflation rate from its peak of 4.6% in February to 1.6% in October, increasing consumer purchasing power. Lower inflation also fostered September’s cut in interest rates, adding fuel to a robust housing market. Lower prices and increased competitive pressures also helped stimulate firms to invest more.

Canada’s current account surplus jumped over $2 billion to $7.3 billion in the third quarter, its highest level since early in 2001 (when California’s energy shortage sent our exports soaring). Virtually all of the increase originated in trade in goods, partly as the exchange rate’s record rise in the second quarter moderated in the third while commodity prices remained high. Elsewhere, the most notable movement was another increase in the travel deficit, as Canadians resumed travelling abroad after the Iraq war but visitors to Canada did not fully rebound.

In recent years, the counterpart to our current account surplus has been primarily direct investment abroad and purchases of foreign (mostly US) stocks. However, the steady reduction in our surpluses since 2001 slowed both direct investment and stock purchases abroad into the first half of this year. The upturn in our current account surplus in the third quarter was reflected in an immediate increase of over $2 billion in both direct investment abroad and stock purchases (not seasonally adjusted).

The pick-up in direct investment abroad was facilitated by the rising exchange rate, which increased the purchasing power of companies with Canadian dollars looking to make acquisitions abroad. Another sharp climb in the exchange rate in September and October, to a 10-year high of 77 cents (US), accompanied a number of takeovers of US firms by Canadian companies. The rising exchange rates also makes foreign takeovers of Canadian companies more expensive: as a result, foreign direct investment was at an 8-year low in the third quarter.

Our net lending to the rest of the world (the mirror image of our current account surplus) is also the by-product of a surplus of domestic savings. Virtually all of this originated in a $71 billion surplus in the corporate sector (at annual rates); governments ran a small surplus while households were net borrowers. Corporate profits recovered after exchange rate-induced losses helped reduce them in the second quarter, while business spending was flat (increases in fixed investment were offset by a drop in inventories).

A number of factors contributed to the burgeoning surpluses in corporate Canada. The upheaval caused by the run-up in the exchange rate over the past year may have forced firms to reconsider their longer-term strategies. For example, foreign mergers and acquisitions began to pick up in the third quarter, and takeovers of US firms multiplied in October. One strategy that firms have not changed is repaying short-term debt.

Labour Markets

Employment rose 0.3% in November, its third straight month of solid growth. Once again, full-time positions accounted for virtually all of the increase. A 0.2% expansion of the labour force held the drop in the unemployment rate from 7.6% to 7.5%.

Manufacturers led the way in jobs, with a 1.0% increase after cutting payrolls for most of the past year. The resumption of growth, after a levelling off in October, suggests the improving trend of US demand was overcoming the effect of a rising dollar on exports. Factories had trimmed payrolls by over 100,000 in the previous year. Services continued to respond to strengthening domestic demand, led by trade, recreation and accommodation and food. The public sector also expanded by 0.5%.

Quebec dominated the increase in employment, led by services. This follows several months of above-average gains in areas such as retail sales and housing, which began to be reflected in jobs starting in October. BC held on to its large advance the month before. The maritime provinces all made sizeable gains. Ontario continued to lag behind, as a recovery in manufacturing was offset by losses in education and health.

Leading indicators

The composite leading indicator continued to strengthen for a fifth straight month, with a 0.6% increase in October after an upward-revised hike of 0.8% in September. These were the largest back-to-back gains since early in 2002. The housing components continued to lead growth. An upturn in business spending also gave a boost to the overall index.

All the indicators related to household demand improved some more, dominated by the housing sector. Housing has accelerated every month since a dip in April 2003, with a 3.6% jump in October raising the level to a 30-year high. Both housing starts and existing home sales contributed to this record-setting performance. The strength in housing spilled over into higher sales of furniture and appliances. Demand for other durable goods rose for a fifth straight month. Household spending was reinvigorated by the largest consecutive gains in full-time jobs since the start of the year, just as interest rates and consumer prices fell.

The growth of the US leading indicator eased slightly from 0.5% to 0.4%, although the number of components rising increased from 7 to 10. As in Canada, housing demand spearheaded the advance, with housing starts hitting their highest level since the early 1980s. Inflation moderated in the US, while tax cuts boosted disposable incomes. Manufacturing reacted positively to the improvement in final demand, with new orders up for both consumer and investment goods. The average workweek rose for the first time since June 2002, an encouraging sign for factory jobs (which have fallen every month since last June).

Business spending in Canada also showed signs of improving. In manufacturing, the ratio of shipment to stocks of finished goods ended a six-month slide, with a majority of industries posting better inventory results. Manufacturers again trimmed the average workweek, but held the line on jobs after cutbacks through most of this year. Services employment was lifted by the first gain in business services in six months. The improved business climate also led firms to step up new equity issues as the stock market resumed its climb.

Output

Monthly GDP rose 1.1% in September, more than making up for the 0.7% loss in August. Goods-production jumped 1.6%, recouping the 0.5% drop when major power users in Ontario were asked to cutback on energy consumption. While the business sector, especially manufacturing, appears to have recovered both output and growth opportunities lost to the blackout, the government sector returned only to its July level of output. This implies that the losses due to the blackout were not fully recouped, and this dampened overall output in the third quarter.

Manufacturers revved up production by 2.5% after a 1.1% drop. Apart from the resumption of normal operations, the trend improved in a number of sectors. Strong housing demand gave another boost to non-metallic minerals. The recovery of demand for computers and telecoms south of the border lifted output in these industries in Canada for a second straight month. Smelting and refining got a large boost from the end of the strike at Inco. Mining also got another jolt from the discovery of a high-grade ore of diamonds in the north.

Unlike goods, commercial services largely regained the ground lost in August. While growth resumed in some areas hardest hit by the blackout (notably gambling and wholesale trade), demand faltered in a number of other industries. Consumer spending on retail goods and accommodation and food decreased, after holding up well in August. Demand for information fell for a third straight month, notably for telecommunications and publishing. Transportation and business services recovered just part of their drop in August. Only finance and real estate showed robust growth over the last two months, driven by the stock and housing markets.

Household Demand

Household spending remained the driving force of growth in the third quarter, easily surpassing the 0.3% increase in real disposable income. Households ran down savings and increased their debt, especially mortgages. Consumer spending in October continued to favour housing over autos, following a similar pattern in the US.

Retail sales volume fell 0.8% in September, only its second notable monthly decline in what has been a year of solid growth. Most of the drop was concentrated in auto-related components, where the constant stimulus offered by rebates and low finance rates appears to be wearing thin. Auto sales slumped sharply again in October. Unlike the US, these losses were equally distributed between North American and foreign models.

Non-automotive sales were sluggish for a second straight month. Mostly, this reflected a sharp drop in clothing purchases in response to a 1.1% hike in prices. The first increase in the cost of food since the mad cow scare began also triggered a drop in consumption. Furniture and appliance sales remained a bright spot, buoyed by robust housing demand and widespread price discounts.

Housing starts in October rose to an annual rate of 237,300 units, up from an average of 230,700 in the third quarter. Multiple units continued to lead the way, a trend that began in the third quarter. So far this year, ground-breaking on single-family homes has fallen marginally behind its pace in 2002, reflecting a dip in new home sales and a small upturn in the number of vacant units. Existing home sales remained near record levels, notably in BC where jobs expanded significantly.

Merchandise trade

The volume of trade across the border in September recovered all of its losses due to the blackout the month before. However, while the recovery of overall export earnings was complete, lower import prices held down our overall import bill. As a result the trade surplus rose for a third straight month, to $5.6 billion. Autos led the recovery of exports, with a 10% gain accounting for about half the overall increase. Most resource products posted increases of nearly 5%. Lumber led the way, fuelled by the boom in US housing demand (which has offset a slowdown in shipments to China). Energy earnings were boosted by gains for natural gas and a doubling of electricity exports as output returned to normal. Industrial goods rose thanks to a resumption of nickel exports after a labour dispute ended. Farming receipts were aided by a better wheat crop and the resumption of some beef exports. Machinery and equipment edged up for a second straight month, with demand firming for computers and telecom equipment.

Auto imports rallied by 11%, but remained well below July’s level. Business spending on machinery and equipment was boosted by sharp gains for drilling rigs and aircraft. The rising dollar continued to dampen prices of imported consumer goods and machinery and equipment.

Prices

The chain price index of GDP edged up 0.8% in the third quarter, as a pause in the rise of the exchange rate relieved the downward pressure on export prices. However, import prices continued to fall, bringing their drop in the past year to 9% and again lowering prices for sectors with large import content (investment, consumer durables and semi-durables). Housing remained the sector with the largest price increases.

The consumer price index was unchanged between September and October, lowering the annual rate of inflation from 2.2% to 1.6%. This is its first dip below 2% since June 2002, and a dramatic reversal from its peak of 4.6% in February of this year.

The monthly CPI was dampened by lower prices for goods. Energy prices fell 4.5%, notably for gasoline. While the world price of crude rose in November, the effects will be shielded by the rising Canadian dollar. The purchase price of autos also fell, partly as rebates were offered to clear out the 2003 models. Auto prices were at their lowest since October 1996. Other durable goods with a large import content, such as computers, home entertainment and sporting equipment, also saw prices dip.

Offsetting these declines were slight increases for food and services. Food costs were pushed up by the first increase for beef since the mad cow incident in May. Services were led by the rising cost of new homes. In the past year, the cost of services is up 3.5%, compared with a 0.4% drop for goods.

Commodity prices rose in November, led once more by an increase for non-energy prices. Metals again led the way. Gold breached $400 (US) an ounce for the first time since 1995: since early 2001, gold has soared 60%, fuelled by Middle East tensions and the falling US dollar. Nickel hit a 14-year high, fed by voracious demand in China. Oil prices subsided after touching $33 a barrel in mid-month.

Manufacturers saw prices fall for a seventh consecutive month in October, with all of that month’s 0.9% drop due to the rising Canada/US exchange rate. While autos and lumber were most affected, a majority (13 out of 21) of industries saw prices fall. Almost as many (12) have seen prices decline from the previous October.

Financial markets

The Canadian dollar continued to climb, ending November at a 10-year high of 77 cents (US). The exchange rate stood at 72 cents three months ago. Meanwhile, the euro rose to an all-time high against the US greenback.

The stock market rally continued with a 1.1% gain in November after a 5% rise the month before. The market has risen in seven of the last eight months. The surge in metals prices fuelled the lastest increase, with gold jumping 14% after metals posted a double-digit advance in October. Rising energy prices also buoyed related stocks, while real estate strengthened further. Overall growth was reined in by losses in consumer and industrial products.

The recent rally in the stock market led to firms stepping up new equity issues to $2.5 billion in October, the most in over a year. Investors continued to divert funds out of money markets and into non-money market mutual funds, which rose $3.0 billion, the most so far this year. With firms able to raise funds on the stock and bond market, short-term borrowing continued to contract.

Regional economy

In September, Ontario was recovering from the losses caused by the power blackout and the ensuing need to curtail energy use in August. As a result, manufacturing shipments rose substantially in September. Ontario was the only province to register an increase in retail sales. It led the growth in housing starts, which reached their second highest level for the year in October. However, weak exports contrasted with the renewed growth of domestic demand. In September, exports remained below their average level for the previous year, as they have throughout this year.

Exports remained a source of weakness in Quebec too, due to aerospace products, which were about 30% below their peak of July 2001. But if energy—which registered sharply lower prices—and aerospace products are excluded, exports posted a 7% increase instead of a similar decrease since January. Industries related to consumer demand and construction showed enough strength to lift shipments from their low for the year. Existing house sales and housing starts eased after surging in August. A decrease in retail sales coincided with lower consumer prices.

British Columbia continued to dominate the economic picture in the West. Shipments strengthened throughout the third quarter, turning in their best performance since the third quarter of 1999. The rise is largely attributable to a resumption of growth for lumber, metals and machinery, together with continued buoyant domestic demand. Housing starts reached a new peak for the year in October, and their highest level since the early 1990s. Exports also presented a favourable picture, with lumber replacing energy as the mainstay for exports. Earlier this year, energy exports were up by more than $1 billion.

International economies

The world economy performed better than at any time since the height of the boom in 2000. US real GDP growth was revised up to 2.0%. Japan posted a 0.5% increase, although this was still not enough to overcome price deflation and nominal GDP shrank. The euro-zone grew by 0.4%, with Italy, France and Germany all rebounding from declines in the second quarter, while the UK grew steadily at 0.6%. Meanwhile, torrid growth in China continued to fuel strong gains throughout the Far East, aided by a recovery from the negative impact of SARS in the second quarter.

Housing remained the focus of consumer spending in the United States. Housing starts rose 3% to a 1-year high of 1.96 million units, driven by single-family homes. The west led the increase, although the forest fires in California may explain why actual construction did not rise as fast. The strength in housing kept non-automotive retail sales growing at a 0.2% clip in October, with building materials and furniture both continuing to rise at a double-digit annual rate. A second straight drop in auto purchases lowered overall retail sales by 0.3%. E-commerce in the third quarter rose 27% from a year earlier: at $13.3 billion, it represents 1.5% of total retail sales, up from 1.3% last year. Typically, its share jumps in the fourth quarter.

Manufacturing showed more signs of pulling out of its prolonged slump. Despite cuts in the auto sector, output rose 0.1% in October after a 0.7% jump in September. Construction materials led the advance, buoyed by the surge in new housing. Computers and other ICT goods continued to ramp up output as investment recovered. New orders for capital goods rose 8% in September and October, led by communications equipment. Overall, profits grew by 12% in the third quarter: unlike the second quarter, which benefited from new rules on depreciation, growth was due to higher prices and lower labour and non-labour costs. The strengthening confidence of manufacturers in the durability of the recovery was reflected in the first increase in inventories of the year.

Despite the rising euro, third quarter growth in the euro-zone was led by a recovery in exports as lowered investment pulled down domestic demand. Industrial production in the euro-zone fell 0.6% in September, with drops in every sector, notably energy and non-durable consumer goods. New orders (published by Eurostat for the first time) rose 1.9% in the month, boosted by strong gains in transport equipment and machinery. Consumer spending remained weak, with retail sales dropping 0.9% in August after a slight decline the month before. External trade slowed in September, with exports and imports both declining. The unemployment rate held at 8.8%, its highest in three and a half years, while the annual rate of inflation eased to 2% in October.

The German economy expanded 0.2% in the third quarter, after two quarters of similar decline. Growth was almost entirely driven by a surge in exports, up 3.2% after falling 2.2% in the second quarter. Imports contracted, reflecting the 1.6% plunge in domestic demand, its steepest fall since early in 1993. Consumer confidence remained battered by rising unemployment, which is close to a 50-year high, and government welfare reforms. The annual rate of inflation was 1.1% in October, one of the lowest in the euro-zone.

Real GDP in France grew 0.4% in the third quarter, more than offsetting its previous decline. Exports rose 1.1%, while imports were flat. Consumer spending picked up slightly, despite low consumer confidence and high unemployment. The annual rate of inflation held steady in October at 2.3%.

Industrial production was flat in Britain in September, capping two months of decline. Consumer spending, although down slightly in August, continued to post significant gains from year-earlier levels. Exports maintained their downward trend in September, with Britain once again having the largest external trade deficit in the euro-zone. Inflation remained steady, prompting the Bank of England to raise interest rates in November for the first time in three years.

Real GDP in Japan expanded by 0.6% in the third quarter, marking the seventh straight advance. Nominal GDP, however, continued to fall due to price deflation. The two main drivers of growth remained exports and business investment. Exports to China and Hong Kong combined have now surpassed those to Europe. Consumer spending was flat, while government investment dropped almost 4% due to spending cuts. The stock market continued to recover, rising 40% in the past six months.

The South-east Asian nations began to show signs of recovery. China continued to power forward. The trade surplus hit its highest level in over five years in October, despite a 40% year-over-year hike in imports. Retail sales also rose at their fastest pace in two years, up over 10%. Singapore’s economy grew 1.7% in the third quarter from a year-earlier level. Exports soared, while consumer spending, particularly for autos, was brisk. Industrial production remained strong into October, rising 19% from a year-earlier level. South Korea’s economy returned to growth in the third quarter, gaining 1.1% as exports strengthened. The Philippine economy also rebounded as robust farm output offset declining business confidence.

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