Upside Potential for Canadian Retailers

Real consumer spending (goods and services) increased 4.6% in the first quarter, and a 4.0% gain is anticipated in the second quarter. For the year as a whole, consumer spending is expected to increase 4.1% after the 3.9% gain in 2005. The pickup in the pace of consumption will be driven by stronger employment growth and various stimulative fiscal measures by different levels of government, which will leave more money in consumers' pockets. Employment is forecasted to rise 1.8% this year, compared with a 1.4% gain in 2005.

Our calculations suggest that the federal budget alone will, on net, benefit consumers' purchasing power to the tune of $3.8 billion in the current fiscal year. No fiscal measure will be more stimulative to consumer spending than the reduction in the goods and services tax from 7% to 6% on July 1. While consumer demand is expected to soften next year, the pace will remain a strong 3.7%.

Two developments point to the possibility of even stronger consumer spending this year than in our June baseline. First, our baseline forecast assumes that the pace of increases in existing home prices will slow from 12.5% year-on-year (y/y) in the first quarter to 5.8% in the second, with a gain of 6.5% for the year as a whole. National existing home prices, however, rose 12.9% y/y in April, and the data from major cities suggest that this strong pace continued in May. In the optimistic scenario, we assume that existing home prices appreciate 8.5% for the year as a whole. This will drive a greater increase in households' net worth, making consumers feel richer and more comfortable with taking on additional debt.

Second, while we anticipated a modest increase of 18,000 in May employment, the actual gain was a massive 97,000. If there was no payback to this upward surprise in the following months, the level of employment at the end of the year would be about 79,000, or 0.5% higher. In the optimistic scenario, we assume that employment grows 2.1% this year, compared with the 1.8% pace in the base case. The boost to households' balance sheets from the higher home prices and to income from the higher employment would result in consumer spending growing at a 4.0% pace in the fourth quarter of this year, compared with 3.5% in the baseline.

Global Insight's baseline forecast for consumer spending is consistent with a healthy Christmas shopping season for Canadian retailers this year. If the optimistic scenario played out, however, the actual outcome would be much better.