Canada's economy unexpectedly contracts in second quarter, setting up next week's BoC rate decision – The Globe and Mail

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The Canadian economy began to buckle under the weight of higher borrowing costs in the second quarter, bolstering the case for the Bank of Canada to hold interest rates steady next week.

Economic activity fell at an annualized rate of 0.2 per cent in the quarter, led by a drop in housing investment and a pullback in consumer spending, Statistics Canada said Friday. A preliminary estimate for July shows gross domestic product growth was flat that month, suggesting that the economy is flatlining as it moves into the second half of the year.

‘Rate hikes are over and done’: How today’s GDP surprise has shifted the views of economists and markets

The GDP numbers came in well below both Bank of Canada and Bay Street estimates, suggesting that higher interest rates are weighing on the economy more than previously appreciated. That solidifies the argument for the Bank of Canada to keep its benchmark rate steady at 5 per cent next week.

“With the fall in monthly GDP in June and the apparent stagnation in July setting a weak foundation for the third quarter, the Canadian economy may already have fallen into a modest recession,” Stephen Brown, deputy chief North America economist at Capital Economics wrote in a note to clients.

The second quarter contraction was led by a 2.1-per-cent drop in housing investment, which included an 8.2-per-cent fall in new construction and a 4.3-per-cent fall in renovations. Statscan said these declines coincided with the Bank of Canada’s resumption of monetary policy tightening in June, after a five month pause.

Household spending slowed in the quarter, growing 0.1 per cent compared to 1.2 per cent in the previous quarter. Shoppers balked at new passenger cars, furniture and outdoor recreation gears. This was offset by a bump in spending on new trucks, vans and SUVs, which are coming to market after an improvement in auto supply chains.

“While aggregate household expenditures edged up in the second quarter, spending per capita fell 0.7 per cent. In fact, per capita household spending declined in three of the last four quarters,” Statscan noted.

Household spending has been a sticking point for the Bank of Canada, which is actively trying to reduce spending on goods and services to slow the pace of price increases. When the bank restarted interest rate hikes in June, officials called out stronger-than-expected consumer demand as a significant reason for the move.

The latest numbers, alongside sluggish retail data, suggest that Canadian shoppers are beginning to tap out.

Other drags on economic activity in the second quarter included a slowdown in business inventory accumulation, which grew at the slowest pace since the fourth quarter of 2021. Trade also weighed on GDP, with imports exceeding exports.

This is the last major piece of data before the Bank of Canada’s rate decision on Sept. 6. Other releases have generally pointed towards a cooling economy. Notably, Canada lost around 6,400 jobs in July, and the unemployment rate ticked up to 5.5 per cent.

Inflation, by contrast, is proving stubborn. Annual Consumer Price Index growth rose to 3.3 per cent in July, up from 2.8 per cent in June. There was, nonetheless, a slight fall in core measures of inflation which try to filter out volatile price moves.

“Between the half-point rise in the unemployment rate, the marked slowing in GDP, and some cooling in core inflation, it now looks like rate hikes are over and done,” Doug Porter, chief economist at Bank of Montreal wrote in a note to clients. “Now, the Bank of Canada just has to be patient as they wait for inflation to come their way—but that could take some time, especially with oil prices backing up again.”

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