Week in Review: BoC concerned about the weak domestic demand impact

Week in review

Canada – Housing starts jumped 4.3% to 187.3K in January (from 179.6K in the prior month). The increase occurred in urban areas (+6.4%), which more than offset the 15.5% decline in rural areas. The jump in urban starts was driven by multis (+12.3%) while single family homes (-3.8%) posted a decline. On a regional basis in urban areas, there were increases in Atlantic Canada (+45%), the Prairies (+29%) and Ontario (+4%), while Quebec (-9%) and BC (-14%) saw declines.

The Teranet–National Bank House Price Index rose 0.2% in January thanks to gains in 5 of the 11 metropolitan regions covered. On a year-on-year basis, home prices were up 4.7% nationally in January, with above average increases in Toronto (+7.4%), Hamilton (+7.2%), Calgary (+7.1%), Edmonton (+6.1%), Vancouver (+5.1%), and below average increases in Victoria (+4.4%), Winnipeg (+0.4%), and Ottawa-Gatineau (+0.1%). Three cities were in deflation mode on a year-on-year basis: Halifax (-0.3%), Montreal (-1.5%), and Quebec City (- 1.6%).

Manufacturing shipments rose 1.7% in December, much better than the 0.9% increase expected by consensus. The gains could have been even better were it not for the 9.3% slump for petroleum/coal products. In fact, excluding that item, sales were up a massive 3.2%, with broad-based gains. Seventeen of the 21 broad industries saw increases, including a 6.3% jump for transportation equipment which got a lift from both autos and aerospace. In real terms, factory sales rose 2.9%, the biggest monthly increase in 3 years, and that more than erased the declines in the prior two months. All told, December’s factory sales were very good not only because of the consensus-topping headline, but mostly due to the broad based gains. The boost provided by the uptick in U.S. demand and the weaker Canadian dollar, is being felt across the entire manufacturing sector. That said, the volume increase in December was insufficient in offsetting the poor start to the quarter. So much so that real factory shipments ended up contracting 2.7% annualized in Q4. That’s much in line with our view that Canadian GDP growth softened to just under 2% annualized in the last quarter of 2014 after two strong quarters.

Bank of Canada Senior Deputy Governor Carolyn Wilkins explained further why the BoC felt it had to cut interest rates last month. She pointed out that the oil-price shock had increased the downside risks to inflation and “That, in and of itself, warranted a response.” The BoC believes that lower oil prices will pull down the inflation profile, more than offsetting the effect on prices from a lower Canadian dollar. The central bank was concerned that lower headline inflation raises risks that inflation expectations become unanchored in economies such as the Eurozone. And there could be domestic impacts from this because “up to a quarter of the variance in core inflation in Canada can be explained by a common global factor”. She added that lower oil prices also increased the risks to financial stability as lower incomes would lead to an increase in household imbalances. The BoC is concerned that domestic demand will weaken as the impact of this oil price decline spreads through the Canadian economy via channels such as wealth, income, and interprovincial trade.

Even before considering risks brought by lower oil prices, the economic situation isn’t great according to the BoC. The central bank thinks the economy is operating below potential. And it highlights the labour market to make its case: “Measures of economic slack that focus exclusively on the labour market show greater unused capacity than broader measures do”. The Senior Deputy Governor said that the labour market has more room for improvement than the headline unemployment rate suggests. She pointed out that more than one in four people who have part-time jobs would prefer to work full-time, the participation rate of prime-age workers fell substantially, average unemployment duration remains close to its post-crisis peak, and wage increases remain subdued. A model by the Bank of Canada accounting for demographic changes shows excess capacity in the labour market, i.e. the “labour gap,” was about 1.5% at the end of 2014. That’s equivalent to a shortfall of about 270,000 jobs, all of which reflect prime-age and young workers who remain underemployed.

United States – Retail sales fell 0.8% in January, much worse than the 0.4% drop expected by consensus. The prior month was unrevised at -0.9%. January sales were restrained in part by motor vehicles/parts which were down 0.5%. But, excluding autos, sales were also weak, falling 0.9% and disappointing consensus which was expecting just a 0.5% drop. Ex-auto sales were restricted by gasoline which sank 9.3%, a sixth consecutive drop thanks to slumping pump prices. There were also declines in sales of furniture, clothing, food/beverages and sporting goods. Assuming that CPI fell 0.6% in the month (our forecast), then real retail sales were down 0.2% in January. So, retail volume growth is set to slow in Q1 after a hot final quarter of 2014. That’s much in line with our view that U.S. GDP growth will be around 2% annualized in Q1.

The National Federation of independent business index (NFIB) fell to a three-month low of 97.9 in January (from 100.4 in the prior month). Businesses were a bit less upbeat about the sales outlook, hiring, and expansion plans, although all of those remained positive.

The Job openings and Labor Turnover report showed that there were 5 million job openings in December, the highest since 2001. The quits rate, i.e. the number of people who quit their jobs as a percentage of total employment was unchanged at 1.9%, albeit near multi-year highs.

The preliminary estimate for February’s Michigan consumer sentiment index came in at 93.6, down from 98.1 in the prior month. Consumers felt less confident about both the economic outlook (sub-index dropping to 87.5), and current conditions (sub-index fell to 103.1). Both of those sub-indices, however, still remain near multi-year highs.

Weekly jobless claims data for the week of February 7th showed initial claims rising to 304K (from an upwardly revised 279K in the prior week). That was worse than the 287K expected by consensus. The more reliable 4-week moving average fell to 290K. Continuing claims for the prior week fell 51K to 2.35 million.

World – The eurozone’s GDP grew 1.4% annualized in Q4, or +0.3% unannualized. Of the fourteen countries that reported quarterly growth rates (out of 18 eurozone members), ten showed expanding output, three printed negative growth ( Finland (-0.3%), Greece (-0.2%), and Cyprus (-0.7%)) and one was flat, namely Italy. Those posting output gains were Germany (+0.7%), France (+0.1%), Spain (+0.7%), Portugal (+0.5%), the Netherlands (+0.5%), Belgium (+0.1%), Austria (+0.1%), Estonia (+1.1%), Latvia (+0.4%) and Slovakia (+0.6%), all in unannualized terms.

The eurozone’s industrial production was flat in December as gains in Germany, France and Italy offset declines in Spain, Portugal, Greece, Malta, the Netherlands and Finland.