• Canadian real GDP fell by 0.2%
• Weakness extends outside manufacturing

Canadian real GDP posted a 0.2% contraction in February, coming in well below expectations of an increase of the same magnitude. After having recorded a significant decline in December (-0.7%) followed by a near-complete recovery in January (+0.6%), Canadian economic activity fell for the second time in the last 3 months of data.

What is different in February's GDP data is the composition of growth and weakness. In the current cycle defined by the U.S. downturn, weak spots are typically concentrated in export-oriented manufacturing sectors, whereas domestic demand shoulders most of the growth. As in previous months, goods production was down (-0.2%). The only goods-producing industry to record a gain was construction, which comes as no surprise given the surge in housing starts in February. Manufacturing activity recorded another important decline (-0.7%) spread across 16 of the major 21 manufacturing groupings. But, in a new turn of events, weakness extended to the service sector.

Indeed, even while most service sectors posted gains, total service activity still fell by 0.1%. The relatively broad based gains did not carry enough weight to offset significant declines in three key areas: wholesale trade (-1.4%), retail trade (-0.6%), and transportation & warehousing (-0.5%). Previous inventory accumulations and inclement weather were partly responsible for these declines, and we don’t expect consumer spending to fall out of bed, just to take a breather and grow at a more modest pace than previous quarters.

It now looks likely that Canadian real GDP grew by less than 0.5% (annualized) in Q1. While this is certainly better when compared to our March forecast of a 0.4% contraction, this does not mean we've escaped the worst of it. In all likelihood, the knock-on effects from the U.S. slowdown are only beginning to be felt. U.S. economic data show no sign of a bottoming out as of yet. The next interest rate setting meeting of the Bank of Canada will be held in 6 weeks, which should give it plenty of time and data to measure just how much the U.S. slowdown will bite out of Canadian growth and how much further they should lower rates. Q1 growth will likely come in below their 1.0% forecast. Our view continues to be than between now and then, and seeing through the short-term impact of the U.S. fiscal stimulus (we're told the checks are already in the mail for some taxpayers), the bulk of U.S. economic data will point to further weakness rather than near-term recovery. That, alongside Canada’s benign inflation backdrop, suggests further Bank of Canada easing is in the pipeline.

Pascal Gauthier, Economist
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