New GDP data should end talk of rate hike next week
‘Little reason’ for Bank of Canada to veer from its course, Kevin Carmichael writes.
The Bank of Canada’s forecasting unit is having a good year.
Statistics Canada reported Aug. 30 that a surge in exports helped gross domestic product expand at an annual rate of 2.9 per cent in the second quarter, a nice acceleration from the 1.3-per-cent pace recorded in the first three months of 2018.
Canada’s central bank nailed the first-quarter number, and just missed Statscan’s official tally of economic output in the second quarter, predicting growth of 2.8 per cent in its July Monetary Policy Report.
Besides bolstering the reputation of Eric Santor, managing director of the central bank’s Canadian Economic Analysis Department, the new GDP figures will end talk that policy-makers might raise interest rates when they conclude their latest round of policy deliberations next week.
When the Bank of Canada raised its benchmark rate to 1.5 per cent on July 11, it said more increases were coming, but only gradually. Then, indicators started coming in hotter than expected. That prompted economists at Bank of Nova Scotia, the country’s third-biggest bank, to predict a back-to-back increase at the central bank’s next interestrate announcement on Sept. 5.
They made a strong case, but it would have taken an off-thecharts reading of GDP to justify a break with the Bank of Canada’s pledge of “gradual” changes. A number that is only marginally outside the central bank’s forecast suggests the world is unfolding essentially as policy-makers foresaw earlier this summer. Therefore, they will wait.
Second quarter “performance was pretty much bang on Bank of Canada expectations, and so there is little reason for them to alter the path of their policy interest rate,” said Brian Depratto, a senior economist at TorontoDominion Bank.
That path isn’t drawn in permanent ink. Stephen Poloz, the governor, and his deputies on the Governing Council might each have a rough idea of where they think the economy and interest rates are headed. But Poloz insists each policy meeting starts with a blank page and that an assessment of the most recent data will determine the final decision.
Exports surged 2.9 per cent from the previous quarter, led by strong gains in energy shipments and international sales of consumer goods, Statscan said. Those figures show Canadian companies are coping with Donald Trump’s trade war, at least so far. The global economy has been unusually strong for a couple of years, especially in the United States, where GDP expanded at an annual rate of 4.2 per cent in the second quarter.
The trade numbers will please Poloz, who has been predicting a shift to export-led growth since he took over as governor in 2013. His story is only now coming true, and there is reason to wonder if the export boom will last. Trump’s duties could eventually bite and global growth is starting to look less synchronous. Argentina and Turkey, two of the world’s bigger emerging markets, are coping with financial crises and there are worries about China’s ability to fight a trade war with the United States, as the former is more dependent on exports than the latter.
Household spending was the second biggest contributor to growth in the second quarter, suggesting the lowest jobless rate on modern record is bolstering domestic demand. That bolsters the case for higher interest rates, as the central bank has been waiting for signs consumers are coping with previous increases; so far, they appear to be.
Still, there is an important weakness in the latest GDP report.
Business investment in nonresidential structures and machinery and equipment grew only 0.5 per cent in the second quarter after expanding at least 1.5 per cent in each of the previous five quarters.
That matters because the Bank of Canada is counting on business investment to drive growth. A slowdown could mean companies are choosing to reinvest their profits in the U.S. or elsewhere to avoid tariffs, or that they have done all they feel they need to do to keep up with demand.
It is difficult to assess how the Bank of Canada will interpret the investment data. Officials could see it as a sign of trouble and seek to offset weaker business spending by keeping interest rates relatively low.
However, it could also be a reason to raise interest rates. Canada’s economy is growing much faster than the central bank reckons it can manage without stoking inflation. Poloz has argued over the past year or so that he can afford to be patient because all that growth will create new capacity, thus raising the economy’s non-inflationary speed limit. If that phase is ending, policy-makers will feel extra pressure to raise interest rates to keep a lid on prices.
It will be too soon to make that call at next week’s meeting, but it will be something to keep in mind around policy decisions in October and December.