11-010-XIB
Canadian Economic Observer
December 2006

Summary table - key indicators

Overview*

The economy ended the third quarter on a weak note, as a retreat in the auto sector reduced GDP in September. Job growth resumed in October and November, while the stock market hit a record high and commodity prices remained strong.

After hovering around 3% for the past year and a half, the year-over-year growth of real GDP eased to 2.5% in the third quarter. Business investment remained the fastest-growing component of demand, buoyed by a rebound in corporate profits after a dip in the first half of the year. Consumer spending picked up, stimulated by the cut in the GST and continued low unemployment. But housing demand slumped, while inventory growth slowed. Exports bounced back weakly from declines in the first half of the year.

The east-west divide in economic activity was most evident in non-residential building. All the western provinces posted gains, led by year-over-year increases of just over 25% in Alberta and Saskatchewan. Commercial construction led growth, especially in Alberta where the office vacancy rate was near zero. Conversely, spending in Quebec and Ontario fell 8% and 6%, respectively, with weakness in both the industrial and commercial sectors.

However, rapid growth in the west is helping to equalize unemployment rates across the country. The chronic double-digit unemployment rates in the Atlantic region are fading, down to a record low of 9.3% in November. The unemployment rate has fallen over a full point since the start of the year in New Brunswick, Nova Scotia and Newfoundland, to match or exceed the drop in Alberta’s unemployment rate. However, the decrease in the Atlantic provinces was driven more by a shrinking supply of people in the labour force while Alberta’s was the result of rapid job growth.

At 7.4%, Nova Scotia’s unemployment rate was the lowest on record since 1976. Like New Brunswick’s 8.5% rate, this ends the double-digit rates that persisted throughout the 1980s and 1990s and appeared as recently as October 2005 in New Brunswick and August 2003 in Nova Scotia. Even Newfoundland’s 13.7% rate was the first time it was under 14% since early 1982: it was 16.5% at the start of the year, and often exceeded 20% in the 1990s. But the price of these reductions was an exodus of people, especially the young, aggravating the aging of their population.

Labour markets

Employment edged-up 0.1% in November, its third straight increase after three months of no change. Private sector payrolls jumped by 0.5%, but this was largely offset by cuts in the public sector. For the second time in three months, all job growth was in part-time positions.

A large influx of adults into the labour force nudged the unemployment rate up to 6.3%. At 3.1%, unemployment in Alberta remained near last month’s record low. Canadians continued to move to Alberta, where the increase in the adult population equalled Ontario over the last four months, despite Alberta being only one-quarter the size of Ontario. Meanwhile, the population of the Atlantic provinces and Saskatchewan continue to fall, especially young adults who traditionally are the most mobile.

Ontario rebounded from four straight months of no job growth with a 0.3% gain. While manufacturing and construction continued to struggle, trade, transportation and business services picked up. The latter two industries also have led growth in Quebec since the start of the year. Natural resources, especially mining, continued to buttress the BC economy, accounting for almost half (43%) of all job growth in the past year, despite accounting for only 2% of all jobs. This offset a weak service sector.

Leading indicators 

The composite leading index rose by 0.2% in October, continuing its string of moderate growth over the last five months. Household demand remained the driving force of growth, while weak export demand continued to crimp the manufacturing sector.

Fuelled by an upturn in job growth, consumer spending continued to expand at a rapid clip for both furniture and appliances and other durable goods. Strong demand for electronic goods offset a slowdown in auto sales. The housing index levelled off after six consecutive declines, led by an upturn in new construction of multiple units.

Nowhere was the strength in consumer demand more evident than in services employment. Growth in this sector was sustained for a 19th straight month, but the sources of growth have completely reversed since the start of the year. At that time, rapid gains in business services offset losses in personal services. By October, business services fell for the first time in almost two years. Instead, personal services buttressed jobs, growing 0.7%.

Manufacturing demand continued to soften. New orders shrank for the fifth month in a row. Much of this weakness originated in lower export demand from the US. The outlook for exports remains poor, as weakness in the auto and housing markets helped pull down the US leading indicator for a fifth straight month.

One bright spot for manufacturers was that they continued to keep inventories under strict control, leading to a slight gain in the ratio of shipments to inventories. The average workweek was unchanged, a barometer of the determination of manufacturers to control labour costs.

Financial market conditions continued to improve. The stock market ended October close to its record highs set in the spring. The money supply posted its smallest increase in nearly a year.

Output

The volume of GDP contracted 0.3% in September, reversing about half the gains made in July and August. Continued losses in manufacturing were reinforced by a downturn in wholesale and retail trade. Autos were a major factor in all three of these declines.

Manufacturing output slid 1.4%, the largest decline so far this year. The auto sector retrenched for a third straight month, although September’s drop was due to re-tooling, with a widespread fall-out on feeder industries. The lumber industry offset some of these losses, despite weak US housing demand, as firms stepped up shipments to avoid a new export tax in mid-October.

Mining output declined in September after leading growth in July and August. Metal mining fell 5% due to a strike. Natural gas producers slashed output when prices temporarily dipped below $5 per million cubic feet. Transportation was dampened by lower mining and energy output. Construction fell slowly, hampered by a fifth straight drop in home-building.

Overall, services output was steady, despite the declines in wholesale and retail trade. Financial activity was robust, led by banking and the stock market. Demand for business services also strengthened. Travel-related industries expanded for a second straight month. The winding down of the census continued to hamper the public sector.

Household Demand

Retail sales volume held steady in September, capping a strong quarterly advance of 1.3%. Retail sales were 8.3% ahead of last year, the largest year-over-year volume increase on record back to 1998.

Auto sales retreated after two monthly gains in the wake of the GST cut. Auto demand continued to slump in October, although lower gas prices sparked a shift away from cars to trucks and SUVs.

With interest in autos waning, consumers shifted spending to other goods, notably clothing. Clothing purchases jumped 5%, after several months of little growth. Still, clothing sales were up only 0.5% in the third quarter, one-tenth their gain in the first.

Elsewhere, spending on non-automotive durable goods continued to strengthen. Electronics again led the way, notably big-screen TVs, with a 16th straight gain, the longest run of any sector. Furniture and appliances posted their largest advance since January, while demand for computers also rose steadily.

Residential construction fell 2% in the third quarter, its second consecutive drop. Both new home construction and home sales were below their levels of a year-ago, especially in central Canada.

Housing starts rebounded 7% to 223,200 units in October (at annual rates), recovering most of their decline over the previous two months. All of the increase originated in multiple units. Ground-breaking on single-family homes hovered between 90,000 and 100,000 units for an eighth straight month.

Merchandise trade

The current account surplus edged up in the third quarter, but remained well below the record set in 2005. The surplus in goods continued to shrink, with the auto sector slipping into deficit. This was offset by a sharp improvement in investment income, as Canadians reaped the benefit of investing abroad. Merchandise exports posted their first gain of the year, led by record metals prices. Imports rose due to strong consumer and business spending.

Exports fell 2% in September, their first retreat in five months. Slumping US demand for auto and forestry products was compounded by a sharp dip in natural gas prices. Imports also dropped 2%, leaving the monthly trade surplus little changed at $4 billion. Exports posted a year-over-year decline for the first time in over a year, reflecting both lower earnings so far this year and the spike in energy exports after hurricane Katrina last September.

Energy exports suffered the largest monthly decline, mostly due to an 8% reversal in natural gas prices. (The sudden drop in natural gas provoked the bankruptcy of a large energy hedge fund in September.) Subsequently, gas prices have nearly doubled, although they remain well below last year’s high.

Auto and forestry exports continued to weaken. Auto exports in September were down 19% from a year earlier, the largest drop for any sector. Truck exports drove the slump, falling by over one-third to under $1 billion for the first time since June 1998, as US sales of trucks and SUVs plummeted.

Forestry exports fell for the seventh time this year. The downward trend in US demand for lumber was temporarily interrupted by stockpiling before new duties took effect in mid-October as part of the recent agreement on trade in softwood lumber. This was offset by more losses for newsprint demand.

Most other exports held on to their recent gains. Industrial goods were buttressed by record high metals prices, especially for nickel. Higher aircraft shipments buoyed machinery and equipment exports. Food exports grew for a third straight month, led by wheat.

The downturn in imports in September was widespread. Only goods destined for consumers managed an increase, thanks to strong demand for house furnishings and food products. Auto imports tumbled 7%, with sharp declines for both cars and trucks after large gains in anticipation of the summer surge in vehicle sales. Imports of machinery and equipment subsided from their record high in August, mostly due to the volatile aircraft component.

Prices

For the third straight quarter, the implicit price index of GDP was little changed. In the first half of the year, this moderation reflected lower export prices. In the third quarter, export prices firmed, led by metals and energy. Instead, the downward pressure on prices came from consumer goods, reflecting the cut in the GST rate. One constant throughout the year was the rising cost of housing, driven by shortages in Alberta. Import prices edged up steadily, a reflection of the end of the downward pressure exerted by a rising exchange rate. The lower dollar also gave a boost to most manufacturing export prices.

The CPI fell 0.1% between September and October, leaving the annual rate of inflation just below 1% for a second straight month. Almost all of the retreat was due to a 4% decline in gasoline prices after their record drop the month before. The recent decrease in energy prices began to feed through to home heating. As well, the price of clothing and durable goods moderated further.

Elsewhere, housing continued to exert the largest upward pressure on prices. This reflected the soaring cost of new homes, especially in Alberta, as well as rising mortgage rates. Inflation in Alberta is running at 3%, twice the increase in the other western provinces and triple the national rate. The cost of food rose due to a poor vegetable crop and the rising price of wheat on world markets.

Commodity prices rallied for a second straight month following a large reversal in September. Most of these movements originated in energy prices. Natural gas prices led the increase in November, as crude oil hovered around $60 (US) a barrel. Nickel and zinc hit record highs, but copper and lumber fell as US housing demand shrank.

Financial markets

The stock market rose 3% in November to hit a new record high, surpassing the previous mark set in April. The record-setting performance came despite little change in energy and mining, which had driven growth much of the year. As well, the tightening of tax rules led to double-digit losses for income trusts and telecom stocks. Instead, investors bought financial, real estate and consumer stocks, often in search of dividends.

Short-term interest rates were unchanged for a sixth straight month, while bond yields subsided after a brief upturn in October. The Canadian dollar continued to hover just below 90 cents (US), while it fell substantially against the euro.

Household borrowing in the third quarter reflected the divergent trends in spending. Strong retail sales, especially for autos, led to an acceleration of consumer credit. Slower housing demand triggered a second straight drop in mortgage demand.

For the first time in over a year, firms issued more bonds than stocks in the third quarter. However, demand for short-term debt slowed, in line with lower inventory growth in the quarter. Non-residents continued to finance large amounts of debt in Canada, often denominated in Canadian dollars (so-called ‘Maple bonds’). This phenomenon spread to money market paper in the third quarter, with Canadians buying a record $5 billion of foreign paper. Interest earned on these investments boost the current account balance: for example, interest from Canadian portfolio investment abroad has tripled in the last 2 years.

Regional economy

Another all-time high was recorded in the Prairies, with building permits at the third highest level in Canada. For Alberta, the billion-dollar mark was surpassed for the fourth month in a row. The province was second only to Ontario for the value of the permits issued. Business investment pushed machinery and equipment imports to record levels, accounting for a third of the province’s total imports. The drop in retail sales in September could largely be attributed to the unsustainable record levels for auto sales in August.

Manufacturing was at its weakest in Ontario, where there were overall decreases in September and for the third quarter. The drop of more than 20% in production by North-American automobile manufacturers had a substantial impact. Japanese companies operating in Canada partly offset this with another production increase of 4% year-over-year in September. In September, nearly half of all vehicles assembled in Canada were in transplants, twice the level of five years ago. Some of the recent slowdown in manufacturing could have originated in June, when Ontario introduced a program aimed at reducing the electricity bills of major consumers who agreed to stop production in peak periods as a way of limiting rolling blackouts. Consumer demand also was weak. In September, retail sales decreased more there than in other regions. The drop came at a time when the number of travellers visiting the province from the US was down by nearly 150,000 since April. Conversely, the number of Ontarians who went to visit the US did not rise, with gasoline prices remaining relatively high.

In Quebec, wood and paper deliveries posted further decreases in September, while petroleum products dropped 14% as a result of lower prices. Manufacturing remained at the same level as in August, with a 0.9% increase for the third quarter. In particular, the aerospace industries were up 20% in September. Housing starts also were stronger than in September.

British Columbia was the other region aside from Quebec in which manufacturing demand was resilient, as it was in August. This strength could be attributed to metals and machinery, which is not surprising given the growth in the West and strike threats weighing on the steel industry. Lumber shipments remained weak, and were off more than 20% since the beginning of the year.

International economies

In the United States, the housing market continued to slow. Housing starts slumped another 15% to 1.5 million units in October, nearly one-third below their high at the start of the year. Existing home sales inched up in October after seven straight declines. All of the much-publicized drop in US home prices reflects compositional shifts, as the Census Bureau index of constant-quality homes continues to rise.

Retail sales dipped 0.2% in October after a 0.8% drop the month before. Lower gasoline receipts was the major restraint on sales. But the weakness in housing gradually was taking a toll on consumer spending. Building materials and furniture and appliances both fell for a second straight month. Spending remained strong for most non-durable goods.

Manufacturing output slipped for a second straight month. As in Canada, cuts in the auto sector led the drop. Auto assemblies fell in five of the last seven months, as firms struggled to reduce bloated inventories. Outside of autos, output was buoyed by gains in computers and airplanes. However, a sharp drop in new orders for these industries in October raises questions about the sustainability of growth.

The slowdown is having a moderating effect on inflation and the trade deficit. Consumer prices rose 1.3% from last October, their lowest annual increase since June 2002. While lower energy prices led the drop, core inflation also moderated in October. The trade deficit fell nearly $5 billion from its record in August, largely due to lower prices for oil imports.

The pace of economic growth slowed in the euro-zone in the third quarter of the year. Real GDP rose 0.5% after a 0.9% hike in the second quarter, with business investment beginning to replace exports as the engine of growth. Industrial production fell in September after a strong gain the month before, as output fell in every sector, especially consumer goods. New orders also retreated, with demand falling across the board with the exception of slight gains in electronics and transport equipment. The external trade balance tipped back into surplus as rising shipments of chemicals, machinery and vehicles more than offset the growing energy deficit. Exports were buoyed by strong demand from China, Russia and Canada. The unemployment rate was stable at 7.8% in September, while inflation eased from 2.5% last year to 1.6% as gas prices retreated.

Germany posted its seventh consecutive gain, with GDP up 0.6%, fuelled by consumer spending, exports and business investment. Business confidence hit its highest level in 15 years. Industrial production slowed in September following a rapid gain the month before, with new orders following suit after two months of strong increases. The unemployment rate was up slightly in September and inflation inched up to 1.1%.

Economic growth stalled in France in the third quarter, following a robust 1.2% expansion in the previous three months. Industrial production in September lost all of its 0.9% gain from the month before, although new orders picked up. Imports continued to outpace exports, while consumer demand was flat for the second straight month. Both unemployment and inflation continued to ease.

In Italy, real GDP rose 0.3%, half of its gain in the second quarter. Industrial output contracted in September, continuing its recent see-saw pattern. Consumer spending remained tepid, despite lower inflation and unemployment.

The British economy expanded 0.7% for a second straight quarter. Industrial production inched up slightly in September after flattening over the summer. Consumers reined in spending, reversing the 0.5% gain made in August. With inflation at 2.4%, interest rates rose to a 5-year high in November.

Japan’s economy grew 0.5% in the third quarter, matching its pace in the second. Strong business investment and exports offset slowing consumer spending. The economy has been expanding since the first quarter of 2002 and the GDP deflator for domestic demand turned positive for the first time since the recovery began.

The pace of both output and investment slowed in China as government credit controls began to take effect. Industrial production rose 14.7% year over year in October, down from 16% in September, while investment eased to 17% from 24% growth. The trade surplus soared, however, as imports of investment goods fell sharply while exports rose.

Note

* Based on data available on December 1st; all data references are in current dollars unless otherwise stated.