GDP disappointed, but the Bank of Canada is unlikely to change the trajectory of rates

GDP disappointed, but the Bank of Canada is unlikely to change the trajectory of rates

Canada’s economic growth slowed in the first quarter of 2022, but accelerating demand has shown why the Bank of Canada is unlikely to deviate from its rate of rapid interest rate increases.

After adjusting for inflation, gross domestic product grew at an annualized rate of 3.1 percent, decelerating from 6.6 percent in the fourth quarter of 2021, Statistics Canada said on Tuesday. While this growth was in line with central bank expectations, it lagged behind the average estimate of Bay Street analysts, who demanded growth of 5.2 percent.

Weakness in Tuesday’s report was international trade, with both exports and imports declining. However, economists have been largely optimistic about further details – especially that consumers and businesses continue to spend amid dizzyingly high inflation. Final domestic demand grew by 4.8 percent year on year, with household spending, business investment and residential property purchases rising sharply.

The Canadian economy also performed better than other major economies during the first quarter, which was shaken by the COVID-19 Omicron variant. For example, the United States and Japan saw a decline in GDP at the beginning of the year, while growth in the euro area was subdued.

“The relative resilience of the Canadian economy this quarter may be a broader topic for 2022, helped by its heavy commodity component and greater ability to recover in the services sector after two years of severe constraints,” Bank of Montreal chief economist Doug Porter. wrote in a note to clients.

Financial analysts said the GDP report was unlikely to redirect Bank of Canada from its fastest policy tightening pace in decades. The central bank is generally expected to raise its key interest rate by half a percentage point on Wednesday, raising it to 1.5 percent as part of its efforts to slow inflation, which recently reached a 31-year high of 6.8 percent.

The bank’s policy is “now focused almost exclusively on controlling inflation – so a slight lack of growth will not deflect the forthcoming rate hike a bit,” Mr Porter added.

In various ways, the Canadian consumer appears to be in good shape. Compensation of employees increased by 3.8 percent in nominal terms in the first quarter after a two percent increase in the fourth quarter. This was the largest increase in compensation since 1981, with the exception of the third quarter of 2020, when the country reflected off the first wave of COVID-19.

Canadians also hung on more of their money. The household savings rate rose to 8.1 percent of disposable income from 6.9 percent – well above the quarterly average of 3.4 percent during 2010.

Households have accumulated a large amount of savings during the pandemic, especially those in higher income groups, and this helps them to continue spending even at high inflation. Household spending rose by 3.4 percent on an annualized basis, driven by strong purchases of consumer durables.

The downside is that because people are able to spend, it contributes to the rapid rise in consumer prices. Following Wednesday’s rate decision, several analysts expect the Bank of Canada to grow another half a percentage point in July – a rapid growth rate that some households may find difficult to adapt to.

This cycle of tightening monetary policy has already led to weaker sales and falling prices in many lush Canadian housing markets.

However, this shift has not yet been reflected in Tuesday’s GDP report. Investment in residential real estate increased by 18 percent year on year, driven by renovation expenses and costs associated with home purchases.

“The next big positive contribution from residential investment is unlikely to happen again,” Andrew Grantham, chief economist at CIBC Capital Markets, said in a note to the client.

While trade declined during the early months of 2022, Canada’s terms of trade – the price-export ratio – jumped to record levels due to recent increases in commodity prices such as oil and lumber.

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