‘A longer road to recovery’ as economy shrinks

Contraction in Q2 shocks forecasters

Canada’s economic recovery lost momentum in the second quarter after posting consistent growth since the depths of the pandemic and delivered a shock to forecasters.

The economy contracted 0.3 per cent between April and June, or 1.1 per cent on an annual basis, Statistics Canada reported on Aug. 31. Adding to the dismal report, the federal agency delivered preliminary data for July that showed gross domestic product declined 0.4 per cent, a worrisome start to the third quarter.

A decline in housing activity and exports overshadowed gains in business investment, which caused a drag on the economic recovery. It’s the first quarterly drop in GDP since the second quarter of 2020, which saw the economy contract 11.3 per cent, or 38 per cent annualized.

The data completely missed economists’ estimates, which had anticipated growth of 2.5 per cent for the period and quieted initial optimism about broader business reopenings as much of the country exited the third wave of the COVID-19 pandemic.

“The Canadian economy was not quite as resilient as pretty much everybody thought and there’s more ground to make up at this point,” said Benjamin Reitzes, economist and Canadian rates and macro strategist at Bank of Montreal. “It’s a longer road to recovery.”

The surprising figures also contrasted with the Bank of Canada’s estimates of two-per-cent growth for the quarter, which means they will likely revise down their forecast on economic growth.

The data suggests the recovery could be prolonged for an extended period of time than previously thought and reinforces the trickiness that policy-makers have to contend with in steering the economy.

For one, housing has been a sector that experienced a flurry of activity over the pandemic, driven in part by historically low interest rates and extraordinary government stimulus. But, in recent months the real estate market has seen a cooling, which is reflected in the GDP data. Homeownership transfer costs, which includes all costs associated with the sale of a home, declined 17.7 per cent in the quarter.

Exports also experienced negative growth in the quarter, dropping four per cent. Reitzes attributed the declines to woes in the manufacturing and auto sectors that are currently battling global chip shortages and supply-chain disruptions.

At the same time, business investment grew 5.7 per cent in the second quarter but was not enough to recover the losses in housing and exports.

Early July data, the first month that sets up the third quarter, experienced unexpected declines largely attributable to drops in retail, construction and manufacturing activity and further details will be provided in the next monthly GDP report in October.

The numbers could figure into the central bank’s interest rate announcement next week though they likely won’t move the needle, said Sri Thanabalasingam, a senior economist at Toronto-dominion Bank. Rather, policy-makers will likely take on a more cautious tone in response to the data and hold both the interest rate and bond purchases. The central bank in July pared back its bond purchases to $2 billion per week.

Because the data knocks some confidence into how well Canada’s economy manages through viral COVID-19 waves, that throws into question how badly the Delta variant will impact businesses and Canadians looking ahead. “It’s a downside risk to the economic forecast,” Thanabalasingam said. “It could further delay the economy from getting back to full capacity.”