Canada real GDP grew by 3.7% (Q/Q SAAR) in 2019 Q2, significantly above our 3.0% expectation and consensus. It was also a welcomed rebound after the Canadian economy had nearly stalled during the previous two quarters (+0.3% and +0.5% in 2018 Q4 and 2019 Q1, respectively).
Net trade was the largest contributor to growth (+5.6 ppts). Exports of goods and services increased by 13.4% on broad-based gains, while imports fell 4.0% due to the reversal of a single order of aircraft and engines in 2019 Q1. The other expenditure components of GDP moved mostly as expected: growth in household consumption slowed down to a 7-year low (+0.5%) after an unusually strong start to the year and residential investment activity picked up after 7 quarterly contractions in the past 9 quarters. This being said, this morning’s real GDP outperformance was mostly due to a smaller-than-expected drawdown in inventories. Manufacturers, wholesalers and retailers continued to invest in inventories in the second quarter, albeit at a slower pace. The stock-to-sales ratio reached its highest level since 1993 (0.85 in 2019 Q2). This accumulation is likely to hamper production of new goods, one factor supporting our below-trend growth forecast for the remainder of the year.
Bottom Line: The pace of economic growth just reached its fastest pace in two years but Canada faces a gloomier global outlook. A few factors are still supportive for the economic momentum until the end of 2019:
1. According to various surveys, businesses remain relatively optimistic despite the trade war;
2. Lower mortgage rates are likely to generate stronger housing activity;
3. The removal of U.S. tariffs on steel and aluminum bodes well for exports;
4. U.S. consumers, who increased spending by 0.6% m/m in July, remain upbeat.
Overall, we do not see the need for the Bank of Canada to rush into rate cut mode next week: Trade tensions could ease. Germany, China and the U.S. could announce new fiscal stimulus measures.
Additionally, Canada is already importing lower financing rates because of the global race to the bottom in bond yields. The 1.75% policy rate remains below recent 2% inflation readings and lowering rates closer to the zero bound could turn out to be unproductive in the long run as it promotes household and corporate leverage. Of course, one may argue that further deterioration in global conditions and more trade tariffs would force the BoC to reduce its policy rate. Granted, the increase in Germany’s unemployment rate registered in August, a first in 5 years, is another sign that the escalation in U.S.-China trade tensions continue to cripple the global economic momentum. But tariffs could slow economic activity and feed CPI inflation at the same time, which would put our central bank in a challenging situation given its role to achieve low and stable consumer inflation.
For all the reasons above, we doubt the BoC will deliver a very dovish message next week and consequently cut its policy rate at the Oct. 30 meeting.