Week in review
CANADA: The Teranet–National Bank National Composite House Price IndexTM rose 2.6% in June, the largest increase for that month in the index’s 19-year history. Ten of the 11 metropolitan regions registered higher prices in June, led by Hamilton (+4.1%—a record monthly rise), Toronto (+3.7%—also a record) and Quebec City (+3.7%). Price gains were impressive also in Vancouver (+2.5%), Victoria (+2.2%), Edmonton (+1.8%), Halifax (+1.7%), Montreal (+1.6%) and Ottawa-Gatineau (+1.2%). Year on year, the national index was up a record 14.2%, with Toronto (+29.3%—a record), Hamilton (+25.6%—also a record) and Victoria (+17.4%) registering the sharpest gains. Elsewhere, price movements were more subdued and even negative in the case of Edmonton (-0.1%) and Quebec City (-0.6%). The June stats show that the Ontario government’s Fair Housing Plan, which is expected to put a damper on Toronto home price inflation, had not yet had a bearing in this regard. However, given the plan’s effect on home sales and listings (see chart below), the impact on prices should be felt soon enough.
In June, housing starts rose 17.7K (+9.1%) to 212.7K. In urban areas, multiple starts increased 10.9K (+9.4%) to 127.9K while single-detached starts jumped 6.1K (+10.1%) to 66.8K. Rural starts, for their part, edged up 0.7K (+4.0%) to 17.9K. Starts were up in four provinces, including Ontario (+24.4K) and Quebec (+9.2K). They were stable in Saskatchewan and declined in British Columbia (-8.8K) and Manitoba (-4.1K), among others. June’s advance was in part due to a return to a more normal level of starts in Ontario after a weak showing in May, but it also resulted from record activity in Quebec City, where a major condominium project inflated gains. For Q2 as a whole, starts averaged 207.5K. Though this is a strong number, it is nevertheless dwarfed by Q1’s astronomical gains (223.4K on average). Consequently, new residential construction is set to subtract from economic growth in Q2.
The Bank of Canada hiked its policy rate for the first time in seven years, raising the overnight rate 25 basis points to 0.75%. While the BoC acknowledged that inflation remained low—the latest reading showed common core CPI rising only 1.3% on an annual basis—it considered this weakness “temporary” and continued to project inflation close to 2% by the middle of 2018. The central bank also justified its decision by describing the economy as “approaching full capacity”. It suggested that any remaining slack would be absorbed by above-potential economic growth. In this regard, in its updated Monetary Policy Report, the bank raised its real GDP growth forecast from 2.6% to 2.8% for this year and bumped it up one tick to 2.0% for next year. In the meantime, the estimate of Canada’s potential GDP growth was left unchanged at 1.0-1.6% for this year. If growth evolved as forecast, the BoC estimated that the output gap, which stood at about 0.5% of GDP at the end of 2017Q2, would be closed by the end of this year, that is, two quarters earlier than was expected in the last MPR.
This week’s rate hike came as no surprise as the BoC had set the stage for it through its communications. The real question is whether the decision to raise the overnight rate should be seen as a first step in removing the “insurance policy” taken out in 2015 or as the first of a series of upcoming rate hikes. BoC Governor Stephen Poloz was unwilling to categorize the rate decision along those lines. Instead, he pointed out that the economy had evolved since 2014 and could behave quite differently than it did prior to the oil shock. Consequently, the policy rate of 2014 should not to be used as a reference point. Poloz added that “the economy [might] be more sensitive to changes in interest rates than in the past” given current household debt accumulation. This obviously argued in favour of a cautious approach to monetary policy normalization. Yet, in his press conference, Poloz stated: “In the full course of time, I don’t doubt that interest rates will move higher, but there’s no pre-determined path in mind at this stage. It’s a data dependent, quarter-by-quarter analysis that we’ll be doing.”
With interest rates still very low and the bank projecting the output gap closing by the end of this year, we think that there are more rate hikes to come and that the next one will be delivered later this year.
UNITED STATES: The consumer price index was flat in June after retreating 0.1% the prior month. The headline figure was negatively impacted by a 1.6% decline in energy prices and a flat reading in the food category. Not accounting for these two components, core inflation ticked up 0.1% month on month as gains for personal computers, medical care and ex-energy services more than offset the pullbacks observed for apparel, new/used vehicles and tobacco. Shelter prices also continued to decelerate from their vigorous pace of the past few quarters. On a year-on-year basis, headline inflation fell one tenth to 1.6% while core inflation remained unchanged at 1.7%, its lowest level in two years. We are not overly worried by the inflation situation as it could react with a significant lag to economic conditions and particularly to import prices. On the latter front, we estimate that deflationary pressures in the goods sector are about to fade over the next few quarters.
Retail sales fell 0.2% in June, following an upwardly revised 0.1% drop the previous month. Sales of motor vehicles and parts edged up 0.1%, a third consecutive monthly gain for that category. Excluding autos, sales also retraced 0.2% after a 0.3% slide in May. The decrease in ex-autos sales was due to the gasoline (-1.3%) and food/beverages (-0.4%) categories which more than offset advances for general merchandise (+0.4%), building materials (+0.5%) and non-store retailers (+0.4%). Discretionary spending, i.e. retail sales excluding gasoline, groceries, and health/personal care products, was flat in June. Expressed in volume, retail sales slid 0.1% in the month, a result which translated into a lackluster 1.3% annualized print in Q2 following a meagre 1.1% in Q1.
Again in June, industrial production expanded 0.4% month on month (+2.0% y/y) after an upwardly revised 0.1% print in May. That was the fifth consecutive positive reading for that indicator, the longest streak since 2014. The manufacturing output, which represents 78.5% of total industrial production, posted a 0.2% gain as production of motor vehicles/parts progressed 0.7%. Excluding autos and parts, manufacturing production edged up 0.1% as an upswing in the machinery segment (+0.6%) was only partially offset by a decline in computer/electronics (-0.1%). The utilities sector registered a flat reading in May while mining output grew 1.6%. In Q2 as a whole, industrial production surged 4.7% in annualized terms, its best showing since 2014Q2, helped by strong gains in the utilities and mining sectors (+18.5% and +14.1% respectively). Manufacturing output, for its part, expanded at a more modest 1.6% annualized pace.
Meanwhile, the capacity utilization rate in the industrial sector increased from 76.4% in May to 76.6% in June, its highest reading since August 2015. In the manufacturing segment, capacity utilization stood at 75.4%, up from 75.3% the prior month.
According to the Job Openings and Labor Turnover Survey (JOLTS), in May, positions waiting to be filled fell 301K to 5,666K in seasonally adjusted terms. This was the first monthly drop since December and the largest since August 2016 but it came after openings hit their highest level ever in April (5,967K). The details of the report showed hires surging 429K (the largest gain in over 10 years) to 5,472K, just short of the post-recession peak of 5,504K reached in December 2015. Meanwhile separations sprang 251K to 5,259K. The quits rate (quits as a percentage of total employment) in the U.S. private sector climbed to a cyclical high of 2.5%. Though this suggests tighter conditions on the labour market, it has not translated into wage growth. This is perhaps due to the fact that quits over the past several years have largely been in industries that do not require particularly high skill levels. Industries such as food services, hospitality and retailing have access to a large pool of unused low-skill labour that they can tap into to replace departing workers cheaply.
The NFIB Small Business Optimism Index fell 0.9 point to a 7-month low of 103.6 in June. This was the second consecutive month for which the index came in below its 6- month moving average (104.8) after topping the mark for seven straight months. However, it should be noted that the 6-month moving average currently sits at its fourth highest level of the last 30 years and, consequently, continues to indicate buoyant optimism among small firms. According to the survey, a net 33% of polled businesses expected the general economic situation to improve, the lowest figure since November. It need be reminded that the index struck a cyclical high of 50% in December. Moreover, the net percentage of firms expecting better sales over the next three months slid from 22% to 17%, a 7-month low. On a more positive note, the share of polled firms planning capital expenditures in the next 3 to 6 months climbed to a cyclical high of 30%, up 6 points from last November. Interestingly, the increase witnessed over the past few months in the share of firms reporting their intention to invest has been mirrored by the percentage of firms identifying poor labour quality as their main problem. This suggests that the scarcity of qualified workers on the market might be leading firms to consider capital spending as a tempting alternative to hiring.
Consumer credit grew $18.4 billion in May to $3,842.6 billion in seasonally adjusted terms after expanding an upwardly revised $12.9 billion in April. The report showed revolving credit expanded $7.4 billion to $1,018.5 billion and nonrevolving credit expanded $11.0 billion to $2,824.1 billion.
In her semi-annual report on the economy and monetary policy before the House of Representatives Financial Services Committee, Fed Chair Janet Yellen highlighted the general improvement of the economic situation, referring notably to the strong employment situation. She also declared that recent indicators, particularly household spending and business fixed investments, suggested “that growth rebounded in the second quarter”. Where inflation was concerned, Yellen blamed the recent low readings (year-onyear PCE inflation came in at 1.4% in May) on “certain categories” and suggested that, if the economy evolved in line with the FOMC’s blueprint, resource utilization would increase, “thereby fostering a stronger pace of wage and price increases.” That said, “when—and how much—inflation [would] respond to tightening resource utilization” remained a source of uncertainty for the FOMC. Even though Yellen stated that it was “premature to reach the judgment that [we were] not on the path to 2% inflation over the next couple of years,” she seemed to wonder whether price weakness might be more broad-based than initially thought. In any case, Yellen said that inflation would be monitored “very carefully” in the near future.
Moving on to monetary policy, Yellen started by reminding her audience that the Fed’s stance remained accommodative and that positive economic developments would “warrant gradual increases in the federal funds rate over time.” As to what exactly the federal funds’ neutral rate was, Yellen declared that actual rates remained “somewhat below… neutral level” but that they “would not have to rise all that much further to get to a neutral policy stance” as longer-run neutral levels were “below levels that prevailed in previous decades.”
Regarding balance sheet normalization, Yellen reiterated that the Fed would “likely begin to implement the program this year” but gave no clue as to a precise starting date. She also stated that no decision had been made regarding the sequencing of actions, leaving the door open to speculation that the FOMC might announce the beginning of balance sheet reduction before the next rate hike.
We believe that balance sheet normalization will be announced in September and begin in October and that the next rate hike will occur in December. According to our base case scenario, two additional hikes will take place in 2018 instead of the three previously forecasted.
WORLD: In the Eurozone, industrial production expanded 1.3% on a seasonally adjusted monthly basis in May after growing a downwardly revised 0.3% in April. May’s performance was driven by a solid showing in the capital goods segment, which expanded 2.3% on a monthly basis and added 0.7 percentage point to the overall production figure. Production of durable consumer goods (+1.8%), non-durable consumer goods (+1.2%), energy (+0.9%), and intermediate goods (+0.3) expanded as well but had a smaller impact on overall output. Germany’s output, which grew 1.4% in May, was the largest contributor to the Eurozone’s output growth, adding 1.0 percentage point to the overall figure. Output swelled also in France (+1.9%), Spain (+1.6%) and Italy (+0.7%). Even if output growth turns out flat in June, the Eurozone’s industrial production will have expanded 5.7% in Q2 in annualized terms. If so, this would be the best print since 2015Q1. Finally, it is worth noting that, year on year, output grew 4.0% in May, its steepest 12-month increase since August 2011.
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