11-010-XIB
Canadian Economic Observer
December 2007

Summary table - key indicators

Overview*

Employment continued to grow rapidly in October and November. This is a strong indication that the Canadian economy continued to expand steadily despite ongoing turmoil in financial markets and the deepening slump in the US housing market.

Real GDP growth in the third quarter was steady at 0.7%. Fuelled by rising corporate profits, business investment posted its largest gain in over a year.  Consumer spending rose steadily, while housing rebounded from a slowdown in the first half.  Exports also steadied after several weak quarters. As well, inventory levels recovered sharply.

Inventories grew by about $15 billion (at annual rates) in volume in the third quarter. This marks a return to the typical inventory increases seen between the third quarter of 2004 and the third quarter of 2006 (the average quarterly increase during that period was $13 billion). Inventories fell suddenly in the fourth quarter of 2006, and rose slowly in the first two quarters of 2007. As a result, the economy-wide ratio of inventories to sales stood at a recent low of only 0.66 entering this summer, and rose only marginally in the third quarter.

Seen in this light, the third-quarter upswing in inventory accumulation in the third quarter appears to be more related to replenishing low supplies than an unwanted build-up due to lower demand. All sectors of demand expanded in the third quarter, with final domestic demand up 1.1% and exports rising 0.6%. In fact, final sales (the sum of final domestic demand and exports) posted its largest quarterly gain since 2005. Inventories rose mostly because supply was replenished as domestic output (GDP) grew 0.7% and imports jumped 4.4%. The latter was particularly important, as the volume of goods imports had risen only a total of 1.3% in the previous three quarters (despite the rise of the Canadian dollar and lower import prices).

The sectoral distribution of inventory growth supports the scenario that inventories were driven more by higher supply than weak demand. The surge of imports replenished trade inventories by $15.1 billion, after three quarters of almost no net growth. Manufacturers, who were the most susceptible to an unwanted build-up as their exports slowed slightly, kept a tight lid on their inventories, up only $1.5 billion. Lower auto sales also may have contributed to the build-up in retail inventories.

Labour markets

Employment continued to grow vigorously in November, up 0.3% after similar gains in September and October.  The advance was driven by full-time jobs, which accounted for over two-thirds of the increase.  With the labour force surging 0.4%, the unemployment rate edged up from its 31-year low of 5.8% in October to 5.9%.

Private-sector payrolls accounted for two-thirds of the increase, after three months of little growth.  Goods-handling industries (notably transportation) and business services led the way, with gains of over 2%. Construction and education also posted notable increases.  Manufacturing recorded the largest decline, shedding 16,000 jobs to give back all of their gains over the summer.

BC and Quebec contributed most of the increase in jobs.  Almost half of BC’s gain originated in the booming construction industry.  Construction also remained strong in the Prairie provinces, rising at a double-digit rate over the past year.  Unlike Manitoba and Saskatchewan, however, overall employment in Alberta fell due to losses in manufacturing and goods-handling  industries.  Quebec was buoyed by gains in trade and transportation as well as education, outweighing losses in manufacturing.  Ontario’s weakness originated in construction and business investment services, not manufacturing (which was steady).

Leading Indicators

The composite index rose by 0.1% in October after a downward-revised gain of 0.3% in September. Six of the ten components increased, while four declined, the most since last October. The weakness was concentrated in housing starts and new orders, which returned to more normal levels after exceptional gains the month before. Growth was sustained by consumer spending and the financial sector.

The housing index fell 1.7% after three large gains. Both components declined. Existing home sales in the autumn retreated from their record highs set during the summer, while housing starts retuned to more normal levels after a burst of  multiple units sent overall starts to a 29-year high in September.

The underlying trend of household spending remained positive. Spending on durable goods rose another 0.6%, and auto sales remained strong in October. The personal sector also was the driving force behind growth in services employment in October.

Manufacturers continued to be squeezed between sluggish export demand from the US and the rising Canadian dollar. The US leading indicator eked out a 0.1% increase, as strong financial and labour markets overcame more declines in housing. New orders received by Canadian manufacturers fell 1.7%, as the unsmoothed version lost all of its 12.5% gain the month before. Small declines in the average workweek and the ratio of sales to inventories are probably more indicative of the underlying trend of manufacturing.

Output

Real GDP topped its third-quarter gain with a 0.1% increase in September. Lower manufacturing output accompanied gains in most other sectors.

Mining returned to the forefront of growth over the summer. Non-metallic minerals led the way in August and September, reflecting the opening of a new diamond mine. Crude oil output continued to expand, offsetting further losses for natural gas. Construction matched the growth of mining with a 0.4% gain, although the sources of growth shifted to housing from non-residential projects. Elsewhere in the primary sector, forestry received a boost from the end of the strike in BC.

Services were led by growth in goods-handling industries, notably as wholesalers replenished their supplies with imports. Accommodation and food posted a third straight increase, as gains in domestic and overseas tourism offset fewer Americans crossing the border (although the latter did have a negative impact on casinos). Finance and business services posted steady growth.

Manufacturers trimmed output by almost 1%. Auto assemblies fell temporarily, although they rebounded in October as Canada produces a disproportionately large share of the popular cross-over utility vehicles (the US is saddled with most of the unpopular SUVs). Resource-based manufacturers all posted declines: strikes hampered smelting operations, while weak demand led to more cuts in wood and paper. Even some of the more buoyant industries such as aerospace and wireless communications posted losses, although strong orders suggest the declines were only temporary.

Household demand

After a large gain in August, retail sales volume dipped 0.6% in September, leaving sales up 0.3% in the third quarter. This followed one of its largest quarterly gains ever in the second quarter, when large pay-equity settlements in Quebec boosted spending. As well, prices rose slightly in September, after sharp cuts the month before.

Most of the weakness in retail sales was concentrated in durable goods. Unit auto sales fell 2% in September, and posted a similar decline in October. Auto demand has fallen in four of the last five months, reversing most of their gains in the first half of the year. Still, auto sales in 2007 are on pace for their second best year ever (after 2002). Some of the weakness in September reflected consumers balking at higher prices for trucks. Consumer demand for computers also fell sharply when faced with a rare monthly hike in their prices. Consumers did respond to lower prices for clothing by buying 1.5% more in volume.

The three-month slide in existing home sales ended with a slight rebound in October. The largest turnaround was in central Canada. However, new home sales continued to slump in October, hitting a new low for the year. The growing number of unsold new homes helped cut in half the rate of increase in prices for new homes, from over 12% in the fall of 2006 to only 6% this fall.

Merchandise trade

The current account surplus fell from $6.3 billion to $1 billion in the third quarter, entirely due to a smaller goods surplus. While export volume edged up, prices received were squeezed by the rising exchange rate. Meanwhile, import volume soared as prices fell and inventories were re-stocked. The capital account continued to be driven by hefty foreign direct investment, especially in Canada’s mining industry.

The loonie achieved parity in September after appreciating 15% against the US dollar since January. This continued the downward pressure on export prices and therefore sales, which were 2.3% lower than in August. Export volumes, in contrast, dipped only 0.6%.

The value of exports was down overall in the third quarter while export volumes were stable: year-to-date, both values and volumes made gains. Export sales of agricultural products (notably wheat and canola) and industrial goods (mostly metals) led the gain. However, all but the auto and forestry sectors chipped in to the increase of exports.

Simultaneously, the dollar’s rise has allowed Canadian companies to purchase products from overseas at a discount. Canada’s import volumes surged 3.6% in September while their value rose by the more muted 2.2%.

Import volumes reached a record-high in the third quarter, rising three times faster (6% vs 2%) than Canada’s import bill. Nearly half the increase originated in demand for machinery and equipment, up 6% for their largest quarterly increase since the current investment boom began in 2003. Since the dollar started to appreciate in 2003, machinery import values have risen nearly 20%, compared to a 50% gain in volumes.

Imports of autos and consumer goods also posted healthy gains, after three quarters of only small increases. This should leave retailers well-stocked with lower-priced imports entering the Christmas season.

Prices

The implicit price index for GDP fell by 0.3% in the third quarter due to lower energy prices (especially natural gas); excluding energy, prices rose slightly. Consumers and businesses faced smaller price increases, reflecting the drop in import and energy prices. The price of both exports and imports fell about 3% as the dollar rose. Construction remained the largest source of upward pressure on prices, up over 6% in the past year.

The CPI edged up 0.1% between September and October, while the annual rate of inflation eased slightly to 2.4%. This compares with a 3.5% increase in the US CPI. Most of this gap between Canada and the US originated in the lower cost of food and energy in Canada: excluding these, prices rose at a similar rate of 2.1% in Canada and 2.2% in the US.

Prices continued to diverge between the rising cost of services and the falling cost of goods. Most of the upward pressure on services reflected the higher cost of owning a home (up nearly 5% in the past year). But prices also have risen notably for other services, ranging from child care to personal care to cable TV.

Meanwhile, the price of goods fell in October, providing some relief to consumers. Lower gasoline prices led the decrease, down 3.3% (versus only a 0.1% drop in the US, a benefit directly attributable to the higher dollar). The price of autos and clothing also posted large declines, while food recorded a small drop. All these components have a relatively large import content.

Commodity prices eased in November. Crude oil prices flirted with US$100 a barrel for much of the month, but dipped below $90 at month-end. Most metals prices also fell for a second straight month as US industrial demand weakened.

Prices for manufactured goods in October fell for the sixth straight month. All of the 1.1% was due to the rising dollar, and was felt most by exporters of autos, metals and forestry products. Only one of 21 commodities managed to raise prices (the vegetable and cereal group).

Financial markets

After spiking to a record high of US 1.10, the Canadian dollar ended November near parity, about where it started the month. The loonie fell against most other major currencies. Most mortgage and government bond rates eased, while corporate rates rose as investors continued to re-assess risk.

The stock market tumbled 6% in November, erasing the increases in September and October that set new highs. Metals led the retreat with double-digit losses, while energy was hurt by lower oil prices. Consumer stocks also fell sharply. Finance and real estate posted much smaller declines than in the US market.

Corporate access to funds broadly remained unimpaired by the turmoil in some markets. Bond issues again exceeded $3 billion, while short-term business credit continued to grow steadily in October. Bank loans continued to drive growth, and commercial paper remained weak. The money supply recorded a sharp drop in October.

Regional economies

Demand remained the strongest in British Columbia. September retail sales rose by 0.1% in British Columbia and fell in all other regions. As well, it held onto most of its sizable September gain in housing starts in October. A wave of new projects that began in the middle of the year in mining (notably gold and silver) and tourism (ski resorts and the Olympic village) boosted the number of mid-year building permits in British Columbia and was still growing in September (10%) on top of the record set in 2006 (and more than double the number in 2002). Not surprisingly, business bankruptcies fell dramatically this year, as was the case in all of western Canada, and construction is growing steadily. Forestry remains a weak spot, with shipments down throughout the west.

While the West saw a surge of building permits at mid-year, it was Ontario’s turn in September. Non-residential building construction intentions soared above the $1 billion mark for the third time since 1989. The largest increase was recorded in Toronto (close to 50% higher in September 2007 than in September 2006), led by office tower projects. An increase in employment in Toronto of close to 700,000 jobs (31%) over the last ten years is driving demand. Over the previous decade (1987–1997), employment rose only 171,000.

So far this year, machinery imports into Quebec have increased the most (5.8%) of any region, which suggests that businesses are taking advantage of lower import prices to upgrade their machinery. Quebec’s manufacturing shipments and employment are the weakest in the country, with a sixth decrease in shipments in September. The 5.5% decrease in the third quarter is a record decline.

International economies

In the United States, housing remained a drain on the US economy, with existing home sales, housing permits and prices continuing to slide in October. Housing starts registered gains as a rise in condominium-building offset a 16-year low in single family home construction. This increase followed a sizeable drop (-11%) in September. New home sales were up 2% as builders stepped up discounting to clear out inventories.

While the real economy continued to show resiliency, the housing turmoil spilled over into the financial market in November. Stocks tumbled 10% over the month as investors reacted to write-downs from banks with sub-prime ties.

Exports registered a 1% increase in September on the strength of agricultural and industrial goods. Despite rising crude oil prices and record demand for capital goods pushing up the US import bill, exports outpaced imports for the sixth straight month. This led to a further narrowing of the trade deficit to $56.5 billion, its lowest level in over two years.

As a result of the strength of exports and weakening of imports, third quarter real GDP growth was revised upward to 1.2% from 1%. This was its highest level since 2003. In addition to trade, strong consumer spending and business investment contributed to the advance.

To kick off the fourth quarter, October’s retail sales eked out a 0.2% gain, with gas stations, restaurants, grocery stores and building supply stores all posting higher sales. Rising energy and food prices index also buoyed sales figures, raising questions on whether the weakening housing market had permeated the household sector. However, this minor gain was preceded by a much stronger 0.7% jump in sales and followed by a better than expected Thanksgiving weekend and higher auto sales in November.

Manufacturing output retreated 0.4% in October following a revised 0.2% gain the month previous. New orders also retreated 0.4%. Shipments and orders for core capital goods were down, while imports of these products reached record highs.

The euro-zone economy grew 0.7% in the third quarter of the year, accelerating sharply from 0.3% in the second quarter pace due to exports and business investment.  Industrial production fell in September, the first time since April as tighter credit, higher oil prices and a stronger euro dampened demand.  New orders followed suit as every major sector retrenched, led by chemicals and metals.  The external trade surplus continued to expand with a further decrease in the energy deficit and increased demand for machinery and autos.  Trade with India and China grew, offsetting lower exports to the US.  Consumers resumed spending in September despite rising prices for clothing and food.  The unemployment rate fell slightly to 7.2% in October.

German real GDP rose 0.7% in the third quarter, more than double the second, as both business investment and personal expenditure picked up.  Industrial production eased in September after a surge the month before, while new orders retreated for the second time in three months.  Consumer spending rose after a brief respite in August and inflation was steady in October.

The French economy also grew by 0.7% in the third quarter, up from 0.3% in the second.  After being flat in August, industrial production fell in September, while new orders plunged for the second straight month.  Consumer spending was upbeat even as inflation jumped from 1.6% to 2.1% in October. 

Real GDP rose 0.7% in the United Kingdom, down slightly from its 0.8% pace in each of the previous three quarters.  Industrial production fell in September after being weak throughout the summer months.  Steady strength in the sterling continued to dampen export demand.  Consumers reined in spending as rising gasoline and food prices boosted inflation to 2.1%.

Italy’s GDP grew 0.4% after a 0.1% rise in the second quarter.  Industrial production retrenched in September, giving back all of its August gain, while new orders were flat following two consecutive monthly declines.  Consumer demand picked up during the summer after sustained weakness throughout the spring.  Inflation rose to 2.3% in October.

The Japanese economy expanded 0.6% in the third quarter, led by exports to Asia and Europe despite the strengthening yen.  Growth in domestic demand was modest as housing and non-residential construction starts were dampened by building safety rules that came into effect in June.  Consumer spending picked up in September, while the unemployment rate rose to 4%.

Chinese industrial production surged almost 18% year-over-year in October, following a 19% rise the month before.  Automobiles led the gain, along with telecommunications, electronics and textiles.  Retail sales were 18% higher than a year earlier, while consumer prices jumped 6.5% due to rising pork costs.

Note

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