Decrease in investments leads BoC to downgrade its GDP forecasts

Week in review

Canada – The consumer price index fell 0.7% in December, allowing the year-on-year inflation rate to sink to 1.5% (from 2.0%), the lowest since February 2014. In seasonally adjusted terms, CPI fell 0.1%, as four of the eight broad categories saw price declines, namely transportation (- 1.2%), clothing (-0.3%), health/personal care (-0.2%), and alcohol/tobacco (-0.2%) which more than offset increases for recreation/education (+0.1%), shelter (+0.2%), food (+0.5%), and household ops (+0.1%). The core CPI, which excludes eight of the most volatile items, fell 0.3%, but that was not enough in preventing the year-on-year core inflation rate from rising one tick to 2.2%. In seasonally-adjusted terms, core CPI was up 0.2%. In the final quarter of 2014, year-on-year inflation was 1.9% for the headline and 2.2% for the core, almost matching the Bank of Canada’s estimates from the latest Monetary Policy Report which estimated Q4 year-on-year inflation at 2.0% for the headline and 2.2% for the core. The transportation category continues to weigh on the CPI due to slumping gasoline prices. While imported prices will increase a bit in light of the much weaker Canadian dollar (that may partly explain the uptick in food prices in December), price pressures should generally be down thanks to further declines in fuel prices.

Manufacturing shipments fell 1.4% in November, worse than the 0.7% decline expected by consensus. The sales drop was broad based as 16 of the 21 industries saw declines, including a 6% slump for transportation equipment as lower auto sales more than offset better sales of aerospace. In real terms, factory sales fell 1.4%, the second straight decline. Real inventories rose 0.2%. With weak sales and higher stocks, the inventory to sales ratio rose to 1.38 in November, the highest since April.

Wholesale sales fell 0.3% in November, worse than the flat print expected by consensus. There were declines in three of the 7 subsectors, namely machinery/equipment, building materials and farm products which more than offset gains for autos, food/beverage, personal goods and miscellaneous items. Inventories were up 0.1%%. In real terms, wholesale sales fell 0.3%.

Retail sales rose 0.4% in November, better than consensus which was expecting a drop. Sales rose in 5 of the 11 subsectors, but fell 0.3% for autos/parts dealers. Excluding autos, sales rose 0.7% (versus just +0.1% expected by consensus) thanks to healthy gains for sellers of furniture, electronics, clothing, sporting goods and general merchandise, which offset declines for gasoline, building materials and miscellaneous items. In real terms overall retail sales rose 0.8%. The savings reaped by households thanks to cheaper pump prices are helping boost spending on other items. The strong retail volumes will help offset soft results in manufacturing and wholesaling, and support November GDP.

The Bank of Canada surprised markets by cutting the overnight rate by 25 basis points to 0.75%. The BoC supported that decision by highlighting downside risks to growth brought by the slumping oil prices: “The oil price shock increases both downside risks to the inflation profile and financial stability risks.” The BoC didn’t change its forecast for global growth this year (3.4%) as upgrades to the U.S, Eurozone and China were offset by downgrades to Japan and the rest of the world. The central bank bumped its U.S. growth forecast to 3.2% for 2015 (from 2.9%).

With regards to Canada, the central bank downgraded its forecasts for both growth and inflation. Real GDP growth is now expected to be just 2.1% this year (versus 2.4% in its last forecast) and that is based on an assumed $60 average for oil. The downgrade was entirely due to investment whose contribution was lowered from +0.4 to -0.1%, i.e. now a drag on the economy in 2015. Looking at the quarterly growth profile, the BoC lowered most quarters this year, with the first half averaging just 1.5% annualized. The projections for potential GDP were unchanged at 1.9% for 2015. The central bank estimates the output gap was in the range 0.7-0.9% at the end of Q4. Because of the much weaker growth profile, the BoC now sees the output gap only closing “around the end of 2016”, i.e. a bit later than what it had expected last October. The BoC is concerned about the lower terms of trade and expects that to affect income. That’s reflected in the forecast for real gross domestic income growth which was chopped from 1.7% to just 0.6% this year. The central bank lowered its inflation forecasts in light of slumping oil prices with both core and headline inflation not expected to return to 2% before late 2016. The central bank says that “there is an exceptional amount of uncertainty about the profile for total CPI”.

United States – Housing starts rose a consensustopping 4.4% to 1089K in December, from an upwardly revised 1043K in the prior month. The increase in starts was entirely due to single-family homes (+7.2%), which more than offset the 0.8% decrease for multis. Building permit applications fell 1.9% in December to reach 1032K, from an upwardly revised 1052K in the prior month. The decrease was entirely due to permits for multis (-11.8%), which dwarfed the 4.5% increase for single family units.

Existing home sales rose 2.4% to 5.04 million units in December. Sales got a lift from single family units (+3.5%), which dwarfed the drop in multis (-5%). The months supply of homes at current sales rate fell to 4.4, the lowest since January 2013. The median resale price rose to $209,500 and is now 6% higher than year-ago levels. About a quarter of December sales were made to cash buyers, while the share of distressed sales in total sales rose from 9% to 11%.

Markit’s flash/preliminary estimate of manufacturing purchasing managers index ended up at 53.7 in January (down from 53.9 in the prior month). A reading above 50 implies expansion in manufacturing activity. Markit says that slower new business growth was the driver of the decline. The survey’s respondents said that domestic economic conditions continued to boost new orders, although exports remain lacklustre.

Weekly jobless claims data for the week of January 17th showed initial claims falling to 307K from an upwardly revised 317K in the prior week. The more reliable 4-week moving average rose to 307K. Continuing claims for the prior week rose 15K to 2.4 million.

World – The European Central Bank announced a plan to purchase €60 bn of private and public bonds per month on the secondary market starting in March. The ECB intends to carry out the program until September 2016 (i.e. taking total purchases to €1.1 trillion), although it made clear the program could be extended past that date or end sooner depending on whether or not economic objectives are met. The ECB also lowered the rate on its TLTRO loans and kept its deposit rate unchanged at -0.2%.

In China, growth surprised to the upside in Q4 with GDP growing 6.1% at a seasonally adjusted annualized rate in the quarter (or 7.3% on a year-on-year basis). Also positive was the handoff to 2015 which was quite good based on consensus-topping December data for industrial production and retail spending. For 2014 as a whole, China grew 7.4%, the lowest in years, albeit not far from the government’s target of 7.5%.

Flash manufacturing purchasing managers indices for the month of January were released by Markit for a range of countries. In China, the PMI climbed to 49.8 (from 49.6 in the prior month), buoyed by output and new orders. Japan’s PMI rose to 52.1 (from 52.0 in the prior month) thanks in part to new export orders. More importantly, all of the major subindices remained above 50 in Japan. The eurozone’s PMI rose to 51.0, a six-month high (from 50.6 in the prior month) thanks to higher sub-indices for output, new orders and employment. The eurozone’s services PMI rose to a three-month high of 52.3 in January as gains Germany more than offset declines in France.