Marc Dufresne
The latest Canadian GDP report shows that the economy grew by 2.9% annualized in the third quarter, topping expectations of a 1.5% print. Andrew Kelvin, Chief Canada Strategist at TD Securities, joins Greg Bonnell to discuss what it means for tomorrow’s Bank of Canada rate decision.
Transcript
Greg Bonnell: Canada’s economy grew 2.9% in the third quarter, as energy exports outweighed a drop in household spending and housing investment. But heading into next week’s Bank of Canada rate decision, how is our central bank going to view today’s release? Joining us now with more, Andrew Kelvin, Chief Canada strategist at TD Securities. Welcome back to the program.
Andrew Kelvin: Thank you for having me. Always a pleasure to be here.
Greg Bonnell: So what should we make of this GDP? When I was reading it this morning, I was like, well, there’s a bit of this, there’s a bit of that. I can’t wait to get Andrew’s take on it.
Andrew Kelvin: It really was all over the place. If you want to take a very positive spin on where the Canadian economy is, you can find that. As it turns out, growth was much stronger than we anticipated through June, July, and August. You can take that as a sign that there is even less slack in the economy than perhaps we would have estimated 48 hours ago. On the other hand, and this is more towards where I lean, some of the more forward-looking indicators were a little bit concerning. We had a decline in outright terms in household spending. Now, that followed an extraordinarily strong second quarter. So a slowdown there was due, and I think you could perhaps explain that pullback as a product of that very strong Q2, some snap back there. But still, it’s not necessarily a positive sign. Housing investment remains under pressure.
And one of the significant positive contributors to that Q3 number was government spending. I don’t think we’re going to be in a position in 2023 where we see continued above-trend government spending growth. So while it is great to have an upside surprise, some of the forward-looking pieces and some of the segments of the economy that we’ve really depended on over the last two, three, four, five years were showing a little bit of weakness. And we did get a flash estimate for October with the industry level stuff, the monthly stuff. And that suggested that growth in October was roughly flat. So if you’re the Bank of Canada, growth was obviously much stronger than it was in the third quarter, but your 0.5% forecast for Q4, which is where the Bank of Canada thinks growth will come in — and these are annualized numbers. So 0.5% annualized over a quarter is essentially 0. That’s still very much in play, just with that sort of softer handoff into October.
So I think the Bank of Canada can really dig into this, take really whatever fits its priors. And it really comes back to, are they really, really concerned if the trajectory in CPI inflation? There are early signs that monetary policy tightening is working. If they are convinced enough that the tightening in the system is showing up in the parts of the economy they need to show up — household spending and housing — in such a way that it will reduce demand a little bit, slow the economy through 2023, and bring inflation lower that way, they can probably sit back and lift by a relatively modest, by a normal 25 basis points. But if they’re not convinced that the CPI trajectory is under control, they can look at the combination of still very high core inflation, still very high headline inflation — and we don’t think we’ll see any moderation headline inflation for the remainder of this year — and look at the fact that there is perhaps less slack in the economy than they had realized, and say, you know what, we still need to be a little bit more aggressive.
So I think you could make a compelling case for either 25 or 50 basis points here. The big picture for the Bank of Canada, we are getting closer to the end here of this tightening cycle. We think we’ll see a pause, certainly in the early half of — or the first quarter, I should say, of 2023.
Greg Bonnell: Imagine our central bank, or any central banker really trying to bring inflation down through these aggressive rate hikes. Would love a scenario where they slay inflation. They tame it. They bring it back to where it needs to be, and they don’t throw the economy over a cliff. So that brings us to recession risk. It seems that everyone’s sort of baking in a recession of some sort for next year. You take a look at numbers like these and where we might be headed. Is it a done deal or do we really have to sort of assume that we will be in a recession by next year?
Andrew Kelvin: I don’t think it’s a done deal for the simple fact that we expect population growth to be very robust throughout 2023. If we add more people, it makes it harder to have the total economy shrink in size. On a per capita basis, it’s going to feel very much like a recession whatever the outcome is, in our view. We do think there will be a modest recession in the first half of next year, annualized numbers around sort of 0.5% to minus 0.1% for the first two quarters of the year. But those are pretty modest overall in the context of 1 and 1/2%, 2% population growth. Those feel like a bit more significant declines in activity. But the Bank of Canada, I think, from their perspective — the slowdown in the first half of 2023, that is, I think, baked in. I think the Bank of Canada believes that as well. You heard that in their most recent communications that a recession is as likely as not having one in the early part of 2023.
The trick for the Bank of Canada is they need to make sure that when they reach their pause point in early 2023 or perhaps the second quarter 2023 if I’m being too optimistic here — they need to make sure that is the end, that they have done enough to bring inflation under control. Because where things could become very problematic is if it turns out that they stopped prematurely, and then when we get into the end of 2023 or early 2024, they realize that they haven’t, in fact, done enough to bring inflation under control and need to start raising rates again. Because that’s the point where we’ll really start compounding the economic impacts, really start amplifying the increases in unemployment rate. And you start having pandemic mortgages reset at rates around current rates potentially, which would be, I think, a market problem for the Canadian economy.
Greg Bonnell: Now early in the pandemic, obviously, fiscal policy and monetary policy worked together to try to support it. The monetary policy cut spending, cut the cost of borrowing down to nothing. And then the fiscal side shows up and spends big. Is there a risk of a disconnect? If we find a place where the Bank of Canada, the other central banks say, here is our stop point — We’ve done the job. We hold here now. Try to tame inflation, but then the population starts to feel the pain that they’re worried about. Politicians don’t like it when the population feels pain because that reflects back on them. Is there a danger here that fiscal policy undoes monetary?
Andrew Kelvin: It’s always a danger. And I think if you go back to 2020, 2021 this is not to cast blame on the federal government by any means. It was a very difficult, fast-moving situation. Fiscal policy is very hard to sort of fine tune. I mean, to me, the lesson of 2020 and 2021 is fiscal policy is really powerful. So I think it is very important that fiscal agents and the Central Bank act in concert here. Now, in the near term, I don’t see any indication that the federal government is likely to counteract the Bank of Canada’s inflation-targeting efforts. Announcements we’ve seen, we had that fiscal update quite recently. It was, I thought, pretty conservative in terms of the new spending. When you talk about things like targeted, low-income tax credits, these are things that can have big impacts on individual livelihoods of a select group of people without having large-scale inflationary impacts.
If you look at the announcement in Alberta recently, I believe it’s about $2.5 billion approximately will be spent to help relieve the burden of inflation. These sorts of targeted relief programs can help alleviate the biggest hit that comes from the combination of slowing growth and high inflation. But it is important that the Federal government not come out with a large scale fiscal stimulus program here. And I would just say just based on recent announcements from the Federal government, I don’t see any indication that they’re planning one in the spring. But you’re quite right. It’s very easy to say when you’re not being pressured that you’re not going to commit to irresponsible spending. It could be altogether different if the government seems as though it’s flagging in the polls and it’s getting a lot of pressure from its constituents.
I guess the saving grace there is it doesn’t look like we need to see an election until 2025. So there won’t be the sort of near-term pressures that would be on the government the same way there would be if, let’s say, we were staring at a fall 2023 election. Because that would be a scenario where I think there would be a lot more political pressure in play.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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