Canadian Real GDP (Q2 2019)

Temporary trade strength sends GDP growth higher in second quarter, masking weak details 

• Real Canadian GDP grew 3.7% (q/q, annualized) in the second quarter. This was above consensus expectations, as well as the Bank of Canada's 2.3% forecast from July. Nominal GDP, which includes the impact of price changes, was up 8.3%, due in large part to a healthy rise in export prices.
• Beneath the headline, the details were weak. Net trade led the way as exports rose 13.4%, helped by energy products, but also a surge in aircraft shipments that has already faded from the monthly data. Imports contracted by 4% on fairly broad-based weakness. Net trade added an impressive 5.5 percentage points to growth. The other notable gainer was residential structure investment, up 5.5%, breaking its five quarter streak of contraction as a recovery in resale activity was joined by growth in new builds and renovations.
• The key weakness in this report was domestic demand, down 0.7% in Q2. Household consumption was up a paltry 0.5%, held back by a contraction of spending on vehicles and, somewhat surprisingly, non-durable goods. Most concerningly, non-residential investment pulled back. Spending on machinery and equipment fell 32%, not just due to an expected drop in aircraft spending after a strong Q1, but more widespread weakness including cars, industrial machinery, and electrical machinery. Non-residential structures spending was also down, falling 1.8% for a sixth consecutive quarter of contraction.
• Turning the lens to incomes, total employee compensation rose 6.9%, which together with the modest spending in the quarter, lifted the household saving rate up 0.4 points at 1.7%. Corporate income, as measured by the gross operating surplus, rose 15.8%, the fastest gain since 2016. 
• This morning also brought monthly industry GDP data for June. Economic activity rose 0.2%, with 17 of 20 major industries expanding. In contrast to the quarter as a whole, the details here were generally encouraging. The only weak spot of note was a 1.4% decline in the manufacturing sector which Statistics Canada attributed to lower inventory formation – not necessarily a bad thing given elevated stock levels.

Key Implications

• This was a 'less than meets the eye' report. Trade may have surged, but this is in large part due to a May spike that has already washed out of the monthly data. It is also hardly an encouraging sign when a broad-based import contraction accounts for more than a third of the headline gain. Add on domestic demand that has contracted in three of the last four quarters, helped by surprising weakness in investment, and the picture that emerges is hardly one of strength.
• Underscoring this point is the fact that year-on-year growth now stands at 1.6%, and although the June data was more encouraging, a meaningful third quarter acceleration seems unlikely. This suggests an economy struggling to operate near its potential. 
• When it comes to the Bank of Canada's interest rate decision next week, they’re likely to have the same concerns with today's report that we have. Not only were today's details weak, but since the second quarter ended we've seen yet another escalation in the trade wars and associated uncertainty, alongside further weakness in the global growth backdrop and commodity prices. These will come to bear on the 2020 outlook via some degree of markdown. We expect next week's communication to lay the groundwork for a subsequent cut in October amid unresolved trade risks, which we believe will now be the case.
  
   

Disclaimer

This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. This report contains economic analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities that comprise the TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.