Blistering GDP growth increases odds of BoC rate hike: economists

Strong oil and gas activity drives gains, offsetting the slowdown in real estate

Canada’s economy grew at a 4.5-per-cent pace in the second quarter, blowing past even the most bullish estimates and convincing economists the Bank of Canada will raise its benchmark interest rate before the end of the year, perhaps even next week.

Much of the gains were connected with strong oil and gas activity, particularly in May and June. The manufacturing, construction and retail sectors were all strong, easily offsetting a slowdown in real estate activity connected with government measures introduced to tame overheating housing markets in Toronto and Vancouver.

Economists had thought Canada’s economy would slow a bit with the approach of summer. Yet results for the month of June were surprisingly stronger than expected, and that sent economists racing to update their forecasts for the third quarter and the balance of the year.

“While we do expect growth to simmer down somewhat in the second half of the year, we would readily allow that all of the economic surprises have been to the high side in 2017,” said Douglas Porter, chief economist with BMO Financial Group. “In what has become almost a seemingly monthly ritual in 2017, we are nudging up our call on Canadian GDP growth yet again, to 3.1 per cent for the year and 2.5 per cent for Q3 — and would readily allow that there is some upside risk.”

Avery Shenfeld, chief economist of CIBC Capital Markets, said gains in incomes and a rise in the savings rate give Canadian consumers more room to spend during the third quarter. In July, the Bank of Canada raised its benchmark interest rate for the first time in seven years. Most economists expect Canada’s central bank to raise rates yet again this year, but Shenfeld said the strong GDP data leads CIBC to forecast that the next hike might come as early as next week, rather than later.

“We were sitting on the fence, but are now leaning towards a September hike, with some cautionary words in the statement to remind Canadian dollar bulls that they will be very patient on further hikes,” he said.

The markets still think the Bank of Canada will hold off on raising rates until its Oct. 25 meeting. Heading into Thursday’s GDP report, the futures market had pegged the chance of a Sept. 6 Bank of Canada interest rate increase at only 26.5 per cent. Shortly after the GDP figures were released, the odds of a September hike to 1.0 per cent from the current 0.75 per cent had climbed to 33.4 per cent.

Inflation is still low in Canada, while the Canadian dollar remains relatively high. BMO’s Porter said that gives the Bank of Canada room to be patient and not move as early as next week. Still, Porter adds the strong data “all but locks in” a rate hike later in the year.

Economists surveyed by Bloomberg had expected Canada’s second-quarter GDP to grow by about 3.5 per cent, with the median of the 17 estimates at 3.7 per cent. The highest forecast in the data set was 4.0 per cent, an amount handily surpassed in Thursday’s release.

The big surprise on Thursday was the GDP strength in June, with 14 out of 20 economic sectors posting growth. Construction was the main contributor to June’s growth, Statistics Canada said. Economists had thought economic activity would soften with the approach of summer, and that this would herald a slowdown in third quarter growth. Now it looks like the summer was economically hotter than economists had expected.

“Wow. There seems to be no stopping Canada of late,” said Brian DePratto, senior economist with TD Economics. “The solid monthly data for June suggests that Canada still had solid momentum heading into the summer months, with very early tracking suggesting that Q3 growth could be around 2.5 per cent — a solid pace by any measure and one likely to push Canada into excess demand territory.”

DePratto said another rate hike in the fall is “almost certainly a done deal.”