The last 24 hours brought disappointing news for the Canadian economy.
First, the pace of economic growth moderated at a faster pace than expected during the second half of 2017 according to this morning’s release of the GDP report. Real GDP growth advanced by 1.7% q/q annualized in 2017Q4 (below the BoC Monetary Policy Report forecast of 2.5%) and by 1.5% in 2017Q3. Consumer spending growth softened to a seven-quarter low of 2.1% in 2017Q4, led by weaker expenditures in services. Growth in Canadian exports of goods (+3%) stayed below the pace of expansion observed globally. Residential investment soared temporarily (+13%) since several borrowers rushed to buy a unit before OSFI’s stress test rule for uninsured mortgages became effective in January.
The most constructive development of the GDP report was undeniably the 8% increase in non-residential investment from firms in 2017Q4, led by M&E investment. Canadian-based companies added production capacity since foreign companies were less active in the country according to financial account data released on Thursday. More precisely, foreign direct investment (FDI) in Canada stood at its lowest level since 2010 last year ($34B, see chart). FDI in the Canadian energy and mining sector plunged while it stayed low in other industries. Canadian direct investment abroad reached an elevated $100B in 2017, led by increasing investment from Canadians in the U.S. ($82B).
This moderation in Canadian economic growth and unfavorable financial flows occurred before Trump’s tax reform became effective. Moreover, U.S. Donald President Trump announced yesterday punitive tariffs on steel and aluminum imports, a new form of risk surrounding the Canadian and global economic outlook. Canada is the largest source of U.S. imports for both metals. Steel and aluminum are among the most important Canadian commodities exported south of the border (see chart). Such tariffs could bring short-lived upward inflation pressures in the U.S. and higher nominal interest rates, before weighing down on global trade and GDP. Any form of retaliation from Canada, China or other countries against the U.S. would increase the tide of protectionism further, ultimately leading to more harm than good for the global economy.
Bottom Line: The softer-than-expected trend in economic growth observed in late 2017 and the intensifying risk of a trade war are good reasons for the BoC to stay cautious, even though the January CPI report showed further acceleration in consumer inflation. Following the mid-January hike, we have been expecting only one more 25bps policy rate increase this year. Given these new disappointing developments for the Canadian outlook, we remain comfortable with our call.
