By BDC
MONTREAL, Canada – As we entered the final quarter of the year, challenges for the Canadian economy continue to mount, amid still high interest rates that are weighing on many households and businesses. Following a sluggish third quarter, we expect the economy to remain in neutral in the months ahead.
After registering no growth in June, the economy produced a slight uptick in July (+0.2% real GDP). Gains were made in both goods and services producing industries, according to Statistics Canada. The retail sector was the biggest contributor to growth in July, posting its largest monthly gain in over 18 months at +1.0 percent.
For August, Statistics Canada forecasted another month of neutral growth. If confirmed, this would have actually been a commendable performance in the context of Canada’s ongoing economic slowdown.
Households pay down debt
A return to solid economic growth will depend primarily on households since consumer spending accounts for 60% of GDP in good times and bad. Despite interest rate cuts by the Bank of Canada since June, borrowing costs remain relatively high and consumers continue to be cautious.
However, household debt as a proportion of disposable income continued to fall in the second quarter, reaching 175.5 – the lowest level since the first quarter of 2021. This implies that income growth has outstripped credit growth, a positive sign that the Canadian economy is becoming less reliant on consumer debt.
Rate cuts are unlikely to increase the pace of borrowing unduly in the second half of the year because the interest rate level is still restrictive. Households remain cautious about spending as evidenced by rise in the savings rate in the second quarter.
Inflation back on target
The Bank of Canada would have found much to celebrate in its latest inflation report. Not only did headline inflation as measured by the Consumer Price Index (CPI) slowed below the 2.0 percent target mark in September at 1.6 percent, but the central bank’s preferred core measures also saw significant declines compared to August.
These declines are supportive of more interest rate cuts. The economic slowdown, though well entrenched, isn’t at a pace that will be alarming to the Bank of Canada. Therefore, we expect the bank to stick to its game plan and cut the key rate by a further 25 basis points at its October meeting, but the economy and inflation could very well support a bigger cut.
Lower unemployment rates
The unemployment rate ticked down in September for the first time this year, reaching 6.5 percent. Job creation has changed little from month to month since May but ended the third quarter with a bang. In September, 47,000 jobs were created across Canada, compared with 22,000 the previous month. Another good news is that employment gains were concentrated in the private sector (+61,000), a likely indication that businesses are slowly regaining their footing.
Since the start of 2024, overall job creation has amounted to 257,500, yet the unemployment rate has risen consistently every month (other than the recent drop in September) as the pool of workers increased. Hiring difficulties are likely to slow further in relation to an increasing labour supply.
In July, the number of vacancies fell further to just over half a million, almost half the peak reached in May 2022. A wave of retirements continued in August, at a year-on-year level of 310,400.
The impact on your business
- Consumers remain cautious and will continue to postpone purchases of expensive items or turn to substitute products to avoid borrowing more. Find out how you can improve the value of your offerings to maintain sales. Make sure your inventories are well managed.
- Interest rates should continue to fall at a steady pace. This is a good time to review your growth prospects and medium-term development plans in anticipation of a stronger economy ahead.
- The economic slowdown is still very much with us and it’s not too late to adopt good practices and adjust your company’s finances accordingly. It will take time for interest rate cuts to generate momentum in the economy.
US economy still on track for a soft landing
The US economy remains healthy with many indicators still pointing to a soft landing for our southern neighbour, which could lead the Federal Reserve to slow the pace of interest rate cuts.
At its September meeting, the Federal Reserve made its first rate cut, opting for a reduction of 50 basis points. Before the announcement, economists were in agreement that the Fed would lower rates, but there was no consensus on how large the cut would be.
While consumer and business spending has remained strong despite high interest rates, the balance in favour of a more aggressive cut seems to have been tipped by weakening labour market conditions over the summer.
However, the labour market slowdown appears to have been short-lived. In September, hiring picked up again, with a total of 254,000 jobs created. And revisions to the July and August data took average monthly job gains in the third quarter to 186,000.
Indeed, the US economy continues to grow at a good pace, having expanded by 3.0 percent in the second quarter, a healthy improvement on the first quarter’s 1.6 percent. Q2 growth was driven by consumer spending, inventory restocking and non-residential investment.
The target range for the federal funds rate is now 4.75 – 5.0 percent. The majority (17/19) of participants on the Federal Open Market Committee believe that at a minimum a further 25 basis points should be cut by the end of 2024.
Americans continue to spend
American consumers are still on a roll. Leading indicators point to a third quarter of sustained growth for the economy with American households continuing to spend despite high interest rates.
Following a strong increase in July (+0.4%), personal consumption expenditure rose by a further 0.1 percent in real terms (i.e. taking into account price rises) in August. For the first two months of the third quarter, spending rose faster than disposable income.
U.S. savings have slowed continuously since May with the trend continuing in August. Savings as a percentage of disposable income stood at 4.8 percent in August – its lowest level for the year.
A resilient job market
The rebound in the job market in September suggests that fears over the summer of a major employment slowdown may have been misguided, although one month doesn’t make a trend.
Unemployment remains historically low at 4.1 percent and the job vacancy rate jumped to 4.8 percent in August. There were more than eight million jobs available and the ratio of unemployed to job vacancies was still below one (0.9), i.e. there were still more job vacancies than people available for work in the country.
Any deterioration in labour market conditions is likely to be reflected more in rising unemployment than in a decline in job vacancies.
Core inflation stabilizes above target
Inflation as measured by the Personal Consumption Expenditure (PCE) price index stood at 2.2 percent in August, and at 2.7 percent excluding food and energy.
However, while the overall PCE index continued to fall, core inflation data (measured by PCE excluding food and energy, on which the 2.0 percent target is based) have been stagnant for several months now. The core consumer price index (CPI) – another measure of inflation which also excludes volatile food and energy costs – increased at an annual rate of 3.3 percent in September.
So far, all the Federal Reserve’s underlying inflation measures were still more than 0.50 points above target. Another sign that lead us to believe the Fed will temper the pace of rate cuts for the rest of the year.
The impact on your business
- The significant drop-in US interest rates will have an impact on Canada. Anyone borrowing in US dollars will see their interest costs fall, including banks borrowing on the wholesale market. Canadian businesses and consumers could therefore benefit from lower rates south of the border.
- The labour market picked up in September, and US households are still spending lavishly in relation to their disposable income. Moreover, US imports are still on the rise, which are all good news for Canadian exporters.
- The loonie could depreciate further against the greenback, as the interest rate differential between the two countries continues to widen. This is especially true because recent data point to a more resilient US economy that could limit future interest rate cuts on that side of the border. Canadians exporting to the US will be more competitive, but Canadian companies will face higher costs to import goods and services from the US or to trade on international markets.
