Posted Tuesday December 4, 2018


Canada: GDP (Q3 and September)

Trade boosts Q3 GDP; monthly data indicates weak start to Q4; GDP rose by 2.0% in Q3, an increase that was in line with the consensus expectation; but slower than the 2.9% growth in Q2; Net trade lifted GDP by 3.0 percentage points; business investment and inventories made negative contributions; In September, GDP declined by a weaker than expected 0.1%, largely due to a drop in goods production - David Watt

GDP increased by 2.0% in Q3, matching the consensus expectation. The result was stronger than our expectation of a 1.7% gain. In the quarter, net trade was the main factor behind the gain, with smaller contributions from consumption and government spending.

Overall, net trade made a 3.0 percentage point (ppt) positive contribution to GDP growth in Q3. This was the largest boost to GDP growth from net trade since 2016 Q4. Much of the quarterly increase in net trade was due to a sharp 7.8% drop in imports. HSBC's GDP forecast was based on a smaller contribution from net trade.

Meanwhile, inventories, business investment, and residential investment made negative contributions to GDP growth.

In September, economic output declined by 0.1%. This was weaker than the consensus expectation of a 0.1% gain, and below our forecast of a flat reading. In the month, goods production fell by 0.7%, led by declines in oil and gas extraction, and manufacturing. A 0.2% gain in services output could not offset the weak performance on the goods-producing side of the economy


GDP growth slowed to 2.0% in Q3, from the prior 2.9% pace. In our view, apart for the volatility of imports and inventories, the quarterly Q3 GDP report showed some signs of consumer and business caution. Hence, much of the deceleration in growth in the quarter was linked to weaker domestic demand.

While consumption did make a positive contribution to GDP growth in the quarter, the 0.7 ppt contribution was the smallest in since 2016 Q1, and was one-half of the average contribution over the past four quarters. With residential investment also declining in the quarter, we believe that consumption and housing are feeling the pinch of past interest rate increases. This raises questions about where the neutral policy rate is located, and how many more times the Bank of Canada might raise interest rates. BoC Governor Poloz has said that rather than a numerical target, the Bank will look for signs that monetary policy is "no longer stimulating demand."

We also see evidence that consumer behaviour has been slow to change. Notably, even though the housing market has slowed down to some extent, and rising rates are starting to squeeze disposable income, the household sector continues to run a historically large net financial deficit. As a result, gross investment (which is largely housing-related) continues to far exceed gross savings. Reinforcing this point, note that the household net savings rate has fallen to 0.8% of disposable income, matching a 15-year low. It thus appears that as debt growth has slowed, and even though debt service costs are rising and squeezing disposable income, households are attempting to limit the downward pressure on consumption spending. We continue to have concerns that a debt overhang, owing to high levels of debt, will weigh on the rate of growth of consumption in coming quarters.

Meanwhile, business investment made its first negative contribution to GDP growth in seven quarters. There were declines in both non-residential construction and machinery and equipment. Investment in Q3 was a marked reversal from the positive performance over the past few quarters. To the extent that the weak investment in Q3 reflected the uncertainty over the fate of trade negotiations between the US, Mexico, and Canada, the agreement on the USMCA should alleviate some of the business anxiety. This could help to set the stage for improved investment in Q4. Another potentially positive sign is that non-financial corporate profits improved in Q3. That said, there are also mounting signs of downside risks to global economic growth, commodity prices have declined, and there are ongoing competitive challenges that could limit corporate enthusiasm to expand in Canada.

The sharp drop in inventories in Q3 is unlikely to be sustainable, and we look for inventories to make a positive contribution to GDP growth in Q4. However, we are also unlikely to see imports decline as sharply as they did in Q3. We expect reversals in inventories and imports to effectively offset one another in Q4. Hence, we continue to expect GDP growth of only 1.6% in Q4. That said, the decline in GDP in September provides a weak hand-off from Q3, and introduces some downside risk to our Q4 forecast. To reach our 1.6% forecast, GDP will need to expand by 0.2% per month in Q4, which is above the average 0.1% growth observed year-to-date.

The report reinforce our view that the Bank of Canada will leave rates on hold on 5 December.

David Watt is Chief Economist, Canada HSBC

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