CAD: Strong GDP An Upside Risk To BoC Projection

Canada's stronger-than-expected economic performance in July combined with a weak dollar boding well for the all-important exports on which the Bank of Canada bases much of its hopes and expectations, introduces an upside risk to the central bank's GDP projections.

Exports are a key, one of the Bank of Canada's chief hopes as a driver of the new growth out of two negative quarters of technical recession, and although they are improving vis-a-vis the United States, the main market by far, they have yet to gain momentum on a sustainable basis.

A sign that they may be improving further from the last report on September 3 is that Statistics Canada's GDP report on Wednesday showed manufacturing rising 0.6% in July, following the same growth pace in June. There is ground yet to be made up for the long-beleaguered sector on which merchandise exports are based, since its year-over-year performance is still negative (-0.7%). Yet manufacturing seems to be on the rise.

The GDP report Wednesday was promising, with real output up 0.3%, ahead of the 0.2% that a consensus of economists had expected, pulled ahead by the goods producers of the country. Manufacturing was notably strong, although it is something of an irony that the oil industry, hard-hit by collapsed prices, thousands of job layoffs, billions of dollars in investment plans postponed, was the one that led the growth in July as it had in June.

Two consecutive monthly increases for oil and gas extraction, mainly oil and mainly what Statistics Canada calls non-conventional oil, aka the Alberta oil sands, are the backbone of the GDP increases in June and July. Take away mining, quarrying and oil and gas extraction, and July GDP edged up 0.1%.

In any event, the 0.3% increase on the month, seasonally adjusted, provides a solid start to Q3 and analysts believe it presages a growth of 2.5%-to-3.0% for the quarter, far above the Bank of Canada's projection in its July Monetary Policy Report of 1.5% growth in Q3 and 2.5% growth in Q4.

That kind of growth would seem almost certainly to give BOC Governor Stephen Poloz pause and hold the central bank's key policy rate at 0.5%, when the next setting and an accompanying Monetary Policy Report are published on October 21.

To be sure, several arguments supporting a rate cut remain valid, such as the increasingly uncertain global outlook and residual skepticism, or wait-and-see-for-sure attitude, on the part of Canadian business about the certainty of United States growth and export demand before business investment picks up.

There are other cracks in the economy and its outlook. These include a labor market that lags overall real GDP growth, up in August to an unemployment rate of 7.0%. Retail sales are up in July, down in June, and heavily indebted householders may slow consumer spending. Wholesales sales, also, go up and down. Construction is declining. Utilities are down.

The gains of the last two months in oil production are unlikely to be sustained for long.

However, new home building is likely to increase construction employment and activity, with housing starts reaching 217,000 annualized in August. And despite the U.S. Federal Reserve's delay in hiking the federal funds rate, because it remains not quite sure of the strength of the American economy, U.S. demand for Canadian lumber, energy products, some manufactures, may strengthen exports.

The weak CAD, on Wednesday just 74.66 cents to the US$1, is expected finally to show up more closely in export growth than it has thus far. And inflation is not an issue, being held firmly in check.

The pace of growth in Canada may settle down more modestly late in the year, as some temporary boosts fade such as the transitory effects of the world FIFA Cup and the Pan American Games, but more importantly should further oil price setbacks and global alarms occur.

At the moment, though, it appears that the economy has settled into a rebound and that the Bank of Canada may see no need to provide further stimulus. A rate hike, though, would be a long way ahead.