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Canadian Economy Was Stronger Than Expected in the First Quarter31 May 06The Canadian economy grew at an annualized pace of 3.8% in the first quarter of 2006; the annual rate for real economic growth during 2005 was confirmed at 2.9%. This morning’s release of the National Accounts reported that the Canadian economy grew at an annualized pace of 3.8% in the first quarter of 2006, and confirmed that the annual rate of real economic growth for 2005 was 2.9%. The first-quarter growth rate was above Global Insight's most recent forecast of 3.3%, and even more above the private-sector consensus forecast of 3.0%. The unanticipated strength came mostly from the domestic side, although trade was not quite as weak as expected. On the domestic side, residential construction grew at a whopping 14.2% pace, much above expectations. Time will tell whether the decent winter weather explains this strength, or whether order books are full and this strength can be maintained over the year. Consumer spending on housing and durable goods—driven by strong employment growth, modest price inflation, and still-attractive interest rates—was also a major source of strength. Exports were weak, largely in response to the strong dollar, but they were not quite as weak as expected. Moreover, the first-quarter strength cannot be attributed to unusual inventory buildup. This re-enforces our optimism for strong economic growth for 2006 overall. Despite the strong showing, Canada is still lagging U.S. GDP growth. The U.S. economy grew at a 5.3% annual rate in the first quarter. This performance is consistent with expectations that the United States will again outpace Canada in 2006, as has been the case every year since 2002. Today's data confirm that exporters, particularly manufacturers, are having trouble coping with the strong Canadian dollar. Over the past few years, Canadian exporters have been shielded somewhat by the increasing lack of competitiveness imposed upon them by the stronger dollar, because of robust demand from the booming U.S. economy. But it appears now that U.S. growth will be considerably weaker over the next few years. If commodity prices stay strong, manufacturers cannot expect any relief from a Canadian dollar hovering around 90 U.S. cents. The first-quarter strength vindicates the Bank of Canada's May 24 hike in the policy rate. This increase, unlike each of the previous ones dating back to last September, was the subject of considerable debate and contention. In its press release, the bank did indicate it would likely go on hold for the near term to monitor the impact of the tightening cycle. This remains Global Insight's expectation and recommendation for monetary policy. On the fiscal side, the May 2 federal budget was based on a private-sector forecast of 3.0% real and 6.0% nominal GDP growth in the first quarter. Today's new data leave the forecast for nominal GDP (which is the general tax base) about on target, since the slight upside pressure on real GDP forecast is balanced by slight downside news on the GDP price deflator. The full and final impact of this new National Accounts data on Global Insight’s June 2006 short-term forecast awaits a thorough analysis and a running of our econometric model. Nevertheless, with this morning's first-quarter GDP data being slightly above expectations, there is some upside pressure to our current forecast of 3.1% real growth for this year. There could, of course, be interesting revisions at the detailed level as well. We expect to complete the data bank for the June Canadian short-term forecast and analysis in a few days, and will provide our preliminary report at that time. by Dale Orr and Wojciech Szadurski
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