A temporary setback?

Statistics Canada reported today that Canada's GDP fell 0.3 percent in April, its first monthly decline since the corresponding month last year.  Its preliminary estimate suggests a further 0.3 percent decline likely occurred in May. Real GDP remains about 1 percent below the all-time peak set in the last pre-pandemic month, February 2020. 

The April decline was in line with market expectations, and was largely the result of renewed COVID restrictions imposed across the country in response to the third wave of the pandemic.  Twelve of the 20 sectors tracked by StatsCan posted declines in the month, with retail trade posting the biggest contraction at 5.5 percent, as the sector continued to be whipsawed by the ever-changing COVID rules. Manufacturing was also weak, partly in response to the global shortage of semi-conductors, while the construction sector, mining and energy production posted gains. 

StatsCan's preliminary estimate for May suggests that retail trade again led the declines for the month.  However, Canada's vaccine rollout, justly criticized as puny and tardy a few months ago, is now in high gear. As a result, Provinces are steadily removing restrictions on key sectors such as retail and hospitality. Ontario, the most populous Province, has been chastened by the resurgence in the pandemic when it has eased restrictions in the past, so it is moving very slowly this time. This will weigh on the national data for June, but July and beyond are likely to see much stronger results.  

Even with a modest rebound in June, real GDP for the second quarter as a whole is likely to show a slight decline from Q1. However Q3 is likely to turn out very strong, finally allowing real GDP to regain and surpass its pre-COVID level.

Every silver lining has a cloud, of course, and for Canadians it's likely this: the successful vaccine rollout and the imminent recovery in the economy will almost certainly prompt  Prime Minister Justin Trudeau to call a Federal election for early fall, in hopes of regaining a majority in Parliament. As if we haven't suffered enough for the past eighteen months. 

UPDATE, July 1: you want more evidence that an election is coming? Trudeau has shaved off the shaggy beard he's been sporting for over a year and got himself a nice neat haircut. 

And Tiff agrees!

Just hours after the Fed's rate decision and statement, Bank of Canada Governor Tiff Macklem spoke before the Standing Senate Committee on Banking, Trade and Commerce in Ottawa. His opening statement makes it clear that the Bank continues to expect the current inflation spike to wane after the third quarter of the year, and still does not envisage tightening its policy settings until the second half of 2022. Here are a few key quotes, with commentary:

....we forecast strong consumption-led growth in the second half of this year as vaccinations progress further and restrictions ease. Fiscal stimulus from the federal and provincial governments will also make an important contribution to growth. Strong foreign demand and higher commodity prices are expected to drive exports and business investment, leading to a more broad-based recovery. In our April MPR, we projected that the economy will grow by around 6½ percent this year, about 3¾ percent in 2022 and 3¼ percent in 2023.

Two related points here: first, real GDP is already almost back to its pre-pandemic level, so growth at these rates would quickly eat into the surplus capacity that the Bank of Canada is counting on to keep inflation in check. Second, it might be noted that before the pandemic came along, the Bank had been steadily revising its estimates of the economy's potential growth rate downward, to well below the levels it is now projecting. 

Our monetary policy remains grounded in our inflation-targeting framework. The most recent data show that inflation remained above 3 percent in May. Inflation will likely remain near the top of our 1 to 3 percent inflation-control target range through the summer. This largely reflects base-year effects combined with much stronger gasoline prices. As these base-year effects fade, Governing Council expects the ongoing excess supply in the economy to pull inflation back down. In our most recent policy announcement last week, Governing Council judged that the economy still needs extraordinary monetary policy support. We remain committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. Based on our latest projection, this is expected to happen sometime in the second half of 2022, although this timing is unusually uncertain given the difficulties in assessing the economy’s supply capacity. 

The Bank's confidence that base effects are the primary driver of the inflation spike is a little puzzling, given that just yesterday -- i.e. literally hours before Macklem spoke -- Statistics Canada had released above-expectations inflation data for May that it explicitly said were not mainly driven by base effects.  The final sentence of the quoted paragraph at least acknowledges the existence of supply-side constraints that could push prices higher. Risks to the inflation outlook are surely to the upside, especially if the economy achieves the growth rates the Bank is projecting. 

The final sentence of Macklem's remarks could have been lifted directly from the FOMC statement: 

We remain committed to providing the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation objective.

The takeaway from all this is that both central banks know they are going to have to remove the punchbowl at some stage, but both are uncertain and even nervous about starting to do so. 

The inflation spike: scary or not?

Canada's headline CPI rose 3.6 percent in the year to May, according to new data released by Statistics Canada this morning. This was the fastest increase in exactly ten years, slightly above market expectations and a further rise from the 3.4 percent gain posted in April. There is, however, one significant difference between the two months. The April increase was heavily influenced by "base effects",  with April 2020 having been the low point in the first wave of the pandemic, but these effects were much less prominent in May: current inflationary pressures are now a more important factor. 

Price pressures in May were broad-based, with all major components of the index higher year-on-year. The 4.2 percent rise in shelter prices was the fastest since 2008, while a 4.8 percent rise in prices for durable goods was, remarkably, the fastest since way back in 1989.  The year-on-year rise in gasoline prices slipped to 43 percent in May from 63 percent in April as the base effects unwound. If gasoline is omitted from the calculation, the year-on-year increase comes in at 2.5 percent, still noticeably above the Bank of Canada's 2 percent target. 

There is little consolation for the Bank in its three "preferred" core measures of inflation. Each of these moved higher in the month, with one -- CPI-trim -- reaching 2.7 percent, the highest it has been since November 2008. The Bank's conviction that the spike in headline CPI will fade beyond Q3 may yet prove correct, as the base effect for gasoline continues to unwind and other commodity prices, notably lumber, show signs of rolling over. Still, the acceleration in the preferred measure cannot be ignored for much longer if the Bank wishes to maintain the credibility of its inflation targeting regime. 

Of course, today's data from Canada pale in comparison with the corresponding US CPI data for May, which were released last week. Headline CPI rose 5 percent year-on-year, its biggest gain since 2010, while CPI excluding food and energy saw a rise of 3.8 percent, the fastest since 1992. As in Canada, there are base effects in play, reflected most notably in the 28.5 percent rise in energy prices, though this was also influenced by the Colonial pipeline shutdown.  However, also as in Canada there are signs of broader price pressures. Much of the media attention has focused on a huge surge in used car prices, but there are also broad indications that supply chain issues are putting upward pressure on prices.  

The question in both countries is whether the monetary authorities will be forced to respond to these developments.  The Federal Reserve's statement at the conclusion of this week's two-day session makes it plain that it is in no rush to start tightening policy settings. Indeed, it's somewhat striking that the opening sentence of the statement looks almost like a defiant statement of intent: The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.

In practical terms this means that the Fed is keeping its funds target at 0-0.25 percent and maintaining the current pace of quantitative easing. The statement reiterates its desire to see inflation "moderately exceed 2 percent for some time". It is not clear whether a 5 percent rate meets the Fed's definition of "moderately", but the fact that the statement made no acknowledgement whatsoever of the significantly higher data seen in the last two months can perhaps be taken to mean that it still thinks the spike will be short in duration. 

The Fed says that  The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. This is intentionally vague but does not in any way suggest that a change of stance is coming any time soon. For now markets seem willing to trust the Fed, perhaps more than they did a few moths ago, but another print or two like that seen in May could start to change that. 

Bank of Canada: not much to see here

As expected, the Bank of Canada kept its interest rate target unchanged at 0.25 percent today. It also maintained its quantitative easing (QE) program at the current pace of C$ 3 billion per week. The Bank remains "committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In the Bank’s April projection, this happens sometime in the second half of 2022".

Despite today's decision, much of the media release could be read as a case for a much earlier tightening move. Indeed my own former shop on Bay Street, TD Economics, apparently believes a rate hike could come sooner than the Bank expects, if there is an "explosion" in growth.  Consider these excerpts from the media release: 

Regarding growth: after acknowledging that Q1 GDP growth fell short of the Bank's expectations, the release goes on to state that "With vaccinations proceeding at a faster pace, and provincial containment restrictions on an easing path over the summer, the Canadian economy is expected to rebound strongly, led by consumer spending. Housing market activity is expected to moderate but remain elevated. Strong growth in foreign demand and higher commodity prices should also lead to a solid recovery in exports and business investment."

Regarding inflation: "the risks to the inflation outlook identified in the April MPR remain relevant....As expected, CPI inflation has risen to around the top of the 1-3 percent inflation-control range, due largely to base-year effects and much stronger gasoline prices. Core measures of inflation have also risen, due primarily to temporary factors and base year effects, but by much less than CPI inflation. While CPI inflation will likely remain near 3 percent through the summer, it is expected to ease later in the year, as base-year effects diminish and excess capacity continues to exert downward pressure."

This growth and inflation outlook hardly seems to support the Bank's intention to stay on the sidelines for another year. A growth spurt in the second half of 2021 seems all but locked in, given the accelerated vaccine rollout and the strong recovery in the US economy. As for inflation, the Bank's complacency looks very much open to challenge.  It is true that much of the recent uptick in headline CPI is related to base effects, but shortages of a wide variety of goods, from lumber to microchips, do not suggest that underlying cost pressures will ease any time soon. The Bank may be comfortable with inflation at the top of its target range over the next few months; financial markets may not feel the same way. 

The Bank justifies its stance in a single sentence:   "The Governing Council judges that there remains considerable excess capacity in the Canadian economy, and that the recovery continues to require extraordinary monetary policy support." The current unemployment rate certainly attests to the presence of slack in the economy, but a large proportion of reported unemployment represents the temporary loss of part-time jobs in sectors hardest hit by COVID restrictions. Those jobs will quickly reappear as restrictions lift in the coming weeks. 

In the meantime, monetary policy is only one element of the "extraordinary" policy support being showered on the economy right now, with the Federal government adding further fiscal stimulus. The Bank's unworried attitude towards inflation may prove correct in the end, but there is little doubt that the risks to its base case are all tilted in one direction. 

May jobs data: south heads north while north goes south

Jobs data for May, released in Washington and Ottawa this morning, reveal sharp differences in the way the US and Canadian economies are coping with the current phase of the COVID pandemic. While the US data should have alleviated concern that the recovery is slowing, for Canada the numbers are further evidence that the second quarter of the year will. see no real growth, or even a slight contraction. 

The Bureau of Labor Statistics reported that the US economy added 559,000 jobs in May, dropping the unemployment rate to 5.8 percent. While this fell short of market expectations for a rise of 650,000, it should be noted that both the March and April figures were revised higher, by a total of 27,000. Total employment in the US remains some 7.6 million below its pre-pandemic peak (February 2020), but the report suggests that a more "normal" level of employment will be achieved in the next few months, particularly since employers in many parts of the country are reporting difficulties in finding the staff they need. 

The picture in Canada is starkly different. According to Statistics Canada, the economy lost 68,000 jobs in May, in the wake of the loss of 207,000 jobs in April. The unemployment rate was little changed at 8.2 percent. Almost all of the jobs lost in May were part-time, reflecting the outsized impact of pandemic restrictions on sectors such as retail, although StatsCan notes that employment in the goods-producing sector also fell in the month, the first time this has happened since April 2020. While public sector employment has risen during the pandemic, the number of people employed in the private sector now stands 564.000 below the peak seen in February 2020.

StatsCan places the blame for the weak employment data for the past two months entirely on the latest round of COVID-related restrictions, which were in full force across the country for virtually the entire month of May. While these restrictions are starting to ease as COVID cases decline,  there will be no significant reopening in the most populous Province, Ontario, until mid-June, meaning that the restrictions will be in place during the week that StatsCan conducts its survey. This points to another flat jobs report for the month, at best, but this could set the stage for very strong job gains across the country in the third quarter of the year. 

11 and out

No, I'm not talking about the Toronto Maple Leafs' abysmal early exit from the Stanley Cup playoffs last night -- everyone knows that the Leafs never make it eleven games into the playoffs anyway. I'm talking about Canada's GDP, which grew for the eleventh straight month in March, but appears to have fallen in April as COVID lockdowns took hold. 

Data released by Statistics Canada this morning show that real GDP rose 1.1 percent in March, up from a 0.4 percent gain in February. The growth was broad-based, with both goods and services output posting matching 1.1 percent gains and eighteen of the twenty industrial sectors recording gains. Even so, real GDP remained about 1 percent below the pre-pandemic peak posted in February 2020.

The picture looks slightly different if we look at quarterly GDP data, also released this morning. Real GDP rose 1.4 percent in Q1, or about 5.6 percent at an annualized rate. This represented a deceleration from the 2.2 percent gain posted in the final quarter of 2020 and was slightly below the analysts' consensus. Oddly enough, the data suggest that real GDP for the full quarter was actually 0.3 percent higher than the pre-pandemic level seen in the first quarter of 2020. This reflects the very sharp fall in GDP in March 2020, as the first wave of the pandemic struck. As I have suggested here in the past, the monthly data will be more useful than the quarterly figures until the COVID-related gyrations are behind us. 

Growth for the month of March was led by the retail sector, which posted a 3.7 percent gain following a  5.9 percent jump in February.  This sector has been particularly hard-hit by COVID restrictions, and the all-too-brief easing of those restrictions during the first quarter of the year contributed to this strong rebound.  The sector was once again clobbered by fresh anti-COVID measures across the country in April as the third wave of the pandemic hit. Falls in retail trade, combined with weakness in manufacturing, real estate and educational services, resulted in a 0.8 percent decline in real GDP in April, according to StatsCan's preliminary estimate. 

There has been a gradual lifting of restrictions in parts of the country during May, but the lockdown in the most populous Province, Ontario, remained in force throughout the month and will only be lifted in stages during June.  This makes it unlikely that May will see any real GDP growth for the country as a whole, but the picture for June is looking considerably brighter. The strong "handoff" from the March data and the relatively modest scale of the decline seen in April could mean that a downturn in GDP for Q2 as a whole may be avoided, and all indications are that the second half of the year will see very strong growth.