October 25, 2022 | 13:58
BMO Business Activity Index — Preparing for the Fall
BMO's Canadian Business Activity Index (BAI) suggests that the summer of revenge spending came to an abrupt stop in September, with the index falling 0.1%. That follows a 0.3% advance in August, as falling gasoline prices supported spending on travel, tourism, and other in-person services. However, with both interest rates and inflation challenging affordability, real activity is starting to give out under their weight. First and foremost, the housing sector has weakened significantly. Residential sales fell 3.9% in September and are likely to remain at depressed levels for the rest of the year. Equity markets also came to terms with the likelihood that central banks wouldn't be reversing course on interest rates any time soon. The decline in equity prices has reinforced the negative wealth effects households were already feeling from falling home prices. Business sales also took a step back in September, as wholesale, retail, and manufacturing volumes are all expected to fall. Discretionary spending is seeing the quickest comedown, with demand starting to recede for previously red-hot segments like electronics, entertainment, travel, and in-person dining. Canadian manufacturers also had to deal with a significant depreciation of the Canadian dollar versus the greenback (the dollar fell more than 4% from the end of August to the end of September). That is adding to domestic costs and, while it does enhance export competitiveness, our predominant U.S. exports (like autos) have been held back by supply constraints. In addition, small business confidence took a step back in the month and sits only a few points above neutral.
The one surprising bright spot for activity (and the housing sector) was the September surge in housing starts, with the volatile urban multi-unit segment leading the charge. Strong population growth remains the ace in the hole for driving residential construction demand over the medium term, though there is likely going to be a slowing of construction activity over the near term. The labour market also recovered somewhat from the weaker showing in August, with the unemployment rate declining two ticks in September. However, most of that improvement came from a declining labour force and slower growth will likely exert upward pressure on the unemployment rate in the months ahead. Equity prices have also rallied in October amid more resilient corporate earnings, which erased part of the pullback in September. However, the Canadian dollar is likely to face further headwinds through at least the end of this year due to aggressive Fed tightening, which further complicates the already problematic inflation situation.
The Bottom Line: The summer spending heat wave has quickly cooled in Canada and, with the Bank of Canada now expected to push interest rates to at least 4.25% by the end of the year, the economy is headed for a chillier period for real activity in the months ahead.
Endnote: BMO’s Canadian Business Activity Index is compiled from ten monthly indicators, with supporting information from Statistics Canada’s preliminary estimates of some indicators, as well as high-frequency data on retail mobility and internal credit card transactions. For more details see, https://economics.bmo.com/en/publications/detail/82f74b6c-fabf-4733-b4d4-33c50adf0d3b/