Most economists were surprised by the latest show of the economy’s persistent strength, which some say raises the odds the Bank of Canada will have to increase interest rates again to stamp out inflation.
Canada’s economy grew at an annualized rate of 3.1 per cent in the first quarter, beating Statistics Canada’s early estimates of 2.5 per cent. The Bank of Canada’s latest forecasts had called for 2.3 per cent growth in Q1.
Household spending was up in the quarter following two periods of minimal growth, the agency said Wednesday, but housing investment slowed in the first quarter amid higher borrowing costs.
StatCan said Canadians particularly spent more on new vehicles in Q1. In a note to clients Wednesday, CIBC senior economist Andrew Grantham ascribed that increase to relief in supply chain kinks meaning previous car orders could finally be delivered.
Canadians also returned to dining out and vacations in the quarter, Statistics Canada said, with spending picking up for food, alcoholic and non-alcoholic beverages and travel expenditures.
Dawn Desjardins, chief economist at Deloitte Canada, told Global News that the resilient spending habits of Canadian consumers was the economy’s biggest surprise in the first quarter of the year.
“The consumption numbers were much stronger than we had anticipated,” she said.
“We had anticipated some slowdown in terms of spending activity, given what we’ve seen on the rate side.”
The Bank of Canada’s rapid interest rate increases have raised the cost of borrowing over much of the past year, which, in theory, should limit the amount of disposable income available to consumers.
But Desjardins notes that many Canadian households still had a pile of savings built up from the pandemic that they’ve been able to dig into now that the economy is reopened and they’re able to enjoy the things they couldn’t during lockdowns.
Historically, estimates from economists would say that interest rate changes take around 12-18 months to fully take hold in the economy and consumers’ pocketbooks; Desjardins said that the extra savings have provided a “buffer” that might lengthen how long it takes for higher rates to slow the economy in this cycle.
“These interest rates are biting a little more slowly,” she said.
But Desjardins noted that savings have gradually been whittled down in recent months, suggesting households will be limited in what they can draw on in the quarters to come.
Sh added that the country’s resilient labour market — the unemployment rate has held at 5.0 per cent year-to-date — might have to soften a bit before consumers feel the need to rein in their spending.
Interest rate hike 'on the table' in June
The GDP report comes ahead of the Bank of Canada’s next interest rate decision June 7.
The central bank, which is focused on returning inflation to its two per cent target, paused its aggressive rate hiking cycle earlier this year. Some economists, including Scotiabank’s Derek Holt, have called for the Bank of Canada to act quickly to “crush” inflation with another rate hike sooner than later.
However, governor Tiff Macklem has signalled that the Bank of Canada is still evaluating whether interest rates need to go higher to tame inflation which ticked higher in April.
Tuan Nguyen, economist with RSM Canada, said in a note Wednesday that the strong GDP results help to explain why inflation has been so persistent.
Consumer spending fuels the domestic economy and also puts pressure on inflation; higher interest rates raise the cost of borrowing and push consumers to spend more on debt obligations in hopes of cooling that demand and taking some of the steam out of inflation.
Money markets are pricing in a 40 per cent chance of a hike next week as of Wednesday, up from 28 per cent before the data, and they fully expect an increase of 25 basis points by September.
“That means we should expect a live June meeting where all bets are on the table,” Nguyen said of the market odds. He added, however, that RSM Canada favours another rate hold until additional inflation and jobs market data are available for May.
The next Labour Force Survey comes out June 9.
Desjardins agreed that strong GDP data increases the odds of a rate hike next week, but she believes the Bank of Canada will stay in “assessment mode.” May’s inflation reading, for example, should show a “substantial” decline in the headline figure if only because last year’s numbers were so high in comparison, she said.
Instead, the central bank will be paying close attention to its preferred “core inflation” metrics to see if there has been any easing that could point to further declines in the months ahead, Desjardins said.
“I think the Bank will want to add that to the whole list of items that they’re looking at when they’re deciding whether or not interest rates are sufficiently restrictive,” she said.
Despite the surprising GDP strength there are still some “cracks” in the foundation of the economy, noted RBC assistant chief economist Nathan Janzen on Wednesday.
He said in a note that job vacancies are declining, consumer delinquency rates are edging higher and household savings are depleting as “headwinds from higher interest rates will continue to build.”
Janzen, too, believes the Bank of Canada’s governing council will be “actively” discussing a rate hike in a week’s time — but ultimately, he believes policymakers will wait until July to see if they need to make a move.
“I personally think next week is too early,” Doug Porter, chief economist at BMO Capital Markets, told Reuters. “But I think (the Bank of Canada) will sound a pretty loud warning bell that they could hike rates again.”
Is the hot economy skirting recession?
StatCan had also expected the economy contracted by a modest 0.1 per cent in March, but Wednesday’s release shows economic growth was flat for the month.
Flash estimates for April show growth of 0.2 per cent. Grantham said that was a surprise as the public sector strike in that month was expected to be a drag on growth.
Weakness persisted in Canada’s housing market in the first quarter of the year. New construction was down in every province and territory except the Yukon, StatCan said, while renovations and figures tied to resale activity were also down nationally.
The first quarter GDP figures mark a rebound from what StatCan called essentially flat growth in the final quarter of 2022.
Stronger-than-expected GDP results to start the year come up against calls from some economists for a recession to hit sometime in 2023, which is traditionally defined as at least two consecutive quarters of negative growth.
Desjardins said that while the strong Q1 economic data is a point in favour of a “soft landing” — a scenario where higher interest rates successfully tame inflation but don’t result in a recession — she still sees slowing economic growth on the horizon.
It might not be as deep a recession as others in history, Desjardins said. She pointed to recent surveys of businesses who claim that while they’re not looking to expand their payrolls as much in the next year, they won’t necessarily be shedding a lot of jobs, either.
But a world in which the economy avoids substantial contraction and inflation comes back to the Bank of Canada’s two per cent goal is a difficult balance to strike — especially given the spending habits Canadians were showing in the first quarter of the year.
Desjardins said that when the central bank’s inflation quest has reached its conclusion, a recession might well be necessary to restore price stability.
“A soft landing would be great, as long as it’s taking the sting out of the inflation pressures. And we may need to see negative growth rates for that to occur,” she said.
— with files from the Canadian Press, Reuters