August 31, 2021 | 09:32
GDP: Supply Shock Result
Canadian GDP was shockingly weaker than expected and initial estimates in Q2, falling at a 1.1% annual rate versus expectations of a rise of 2% or better. Making matters worse, the initial flash estimate for the month of July points to a sag of 0.4% at the start of Q3. The one figure that did arrive as expected was the monthly reading for June (up a solid 0.7%), but that was countered by downward revisions to earlier months. Simply, in retrospect, the tough third-wave restrictions in the spring alongside multiple supply chain challenges bit down on activity much harder than the initial estimates suggested. Recall that just one month ago, StatCan's flash estimate for Q2 GDP was for a gain of 0.6% (roughly 2.4% annualized), so this reversal was a shock even to the statistical agency. Another notable factor at work is that much more of rising spending went into price increases instead of a volume gains (a classic symptom of supply shocks)—the GDP deflator was well above expectations at up 9.2% in Q2, yielding nominal GDP growth of 7.9%.
Where was the big surprise in Q2? Consumer spending was expected to show little growth amid renewed restrictions, but it still came in a little light at just 0.2% annualized. But the big clunkers were net trade, as exports were walloped with a 15% drop on supply chain issues, and housing, which fell at a 12.4% clip after a 42% spike in Q1. The weakness in exports was not a complete surprise, but it did drag more heavily than expected. The drop in residential investment, however, was steeper than expected, as the pullback in sales offset decent gains in new building and reno activity. Looking back earlier in the quarter, and helping explain the revised downward view on all of Q2, earlier gains in resources were chopped to declines for mining activity. Meantime, business investment made a solid contribution, as did government outlays, but these simply were not enough to offset the weakness in trade and housing.
Where do we go from here? We suspect that July's drop will reverse in August, but clearly supply issues are dragging in a variety of areas (notably auto sales) while home sales are still pulling back from the early-year surge. We still look for a bump in activity as things erratically reopen in coming months/quarters, but this weak report will leave a mark. As a result fo the drop in Q2 and July, we have shaved our Q3 growth estimate to 3.5% (from 6.0%), which together cuts the full-year estimate for GDP to +5.0% from 6.0%. Note that the Bank of Canada's latest estimate was also for 6.0% growth for the year (and 2.0% in Q2), and consensus was a bit stronger yet—so we are not going to be alone in carving our forecasts today. We are sticking with our call of 4.5% growth in 2022.
Bottom Line: Remember all the commentary about how well the Canadian economy had dealt with the third wave restrictions during the spring? And how businesses and consumers had learned how to operate amid the virus? Well, the reality appears to have been much less constructive, with widespread supply chain issues also causing havoc with growth in the quarter. We will note that spending actually remained robust in Q2, with nominal GDP running at almost an 8% annual rate—the problem is that all of that increase went into price gains. For policymakers, this is where the decisions get exceedingly difficult—when inflation is hotter than expected, but growth weaker. We suspect that the BoC won't turn on a dime on this one figure (albeit a very important figure), and will be anxious to see the August jobs data next week. However, at the very least, there will now be an active debate on the timing of the next tapering step (widely expected to have been in October), and it reinforces the point that rate hikes are at least a year away.