Disappointing GDP growth offsets worries central bank, governments are overdoing it

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Canada’s economy grew at an annual rate of 5.6 per cent in the first quarter, a somewhat disappointing reading that will serve as a counterweight to worries that the central bank and governments have overstimulated the recovery.

To be sure, Statistics Canada’s latest tally of gross domestic product (GDP) is good news when compared with projections at the start of the year. Back then, the Bank of Canada and others were predicting that the second wave of COVID-19 infections would cause a first-quarter contraction. But entrepreneurs and households — aided by extraordinary levels of government support — have found ways to adapt to the pandemic. Overall, the recovery is unfolding at a pace few imagined possible a year ago.

Nonetheless, the GDP figures reinforce something that Bank of Canada governor Tiff Macklem has reiterated at almost every public appearance: the economy’s trajectory will be uneven. So far, the rebound has been overly reliant on housing, and few will be comfortable about the recovery until other growth engines kick in.

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Most Bay Street forecasters had predicted growth of around seven per cent during the first three months of the year. Even the Bank of Canada got ahead of itself, as it also forecast growth of seven per cent in its latest quarterly outlook in April. The actual figures show that adaptation can only accomplish so much when important industries have effectively been closed to reduce the spread of the coronavirus. Separately, Statistics Canada said GDP, as measured by industry output, likely decreased by 0.8 per cent in April, which would be the first monthly decline in a year.

The Bank of Canada has already trimmed its weekly purchases of Government of Canada bonds and said in April that it might opt to raise its benchmark interest rate in the second half of next year, instead of leaving ultra-low borrowing costs in place until some time in 2023. The slightly weaker trajectory for economic growth will probably curb any further retrenchment, at least until policy-makers get a read on how consumers respond as provinces loosen health restrictions this summer.

Housing investment continued to power the economy during the first quarter, accounting for 8.6 per cent of GDP, matching the previous record set in the third quarter of 1987. Spending on real estate surged 9.4 per cent from the fourth quarter, an astonishing increase given it occurred over the wintry months when housing activity typically slows.

The numbers will feed worries that the recovery is overly dependent on a housing rebound that some say has become a bubble in many markets. Excluding the third quarter of last year, when the economy rallied from the epic collapse that came with the first wave of the pandemic, the first-quarter increase in real-estate investment was the biggest since an 11-per-cent jump in the second quarter of 1983.

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Benoit Durocher, an economist at Desjardins Group, observed that excluding real estate, the economy grew at an annual rate of only 2.1 per cent in the first quarter. “There is every reason to believe that the negative effects of the third wave will take a toll on the Canadian economy,” he said in a note. “It is difficult to do otherwise as the most populous province, Ontario, is in the midst of the difficulties.”

There are two reasons to be wary of the economy’s reliance on housing. One is that too much of the money available for investment is being plowed into an unproductive asset, robbing entrepreneurs and executives of the money they need to expand their businesses and create jobs.

Investment in non-residential property, machinery and equipment, and intellectual property was 9.3 per cent of GDP in the first quarter, the smallest level since the second quarter of 1996. The relative importance of business investment and residential investment has rarely been this close; the last time the gap between their respective shares of GDP was this narrow was in early 1987.

The other reason to worry about housing is all the debt households are piling up as they chase runaway prices. As the Bank of Canada warned last month, the most stretched borrowers could be vulnerable to higher interest rates, which are coming eventually. But even if households are safe from default, much of their available income will be tied up in their houses. That means future consumption could depend on households’ willingness to take on yet more debt.

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It remains unclear how much weight to put on either of those risks. Business investment naturally retrenched during the recession, since only the boldest investors deploy capital during moments of extreme uncertainty. Spending on machinery and equipment was $59.5 billion in the first quarter, a decline from the fourth quarter and six per cent lower than a year earlier. At the same time, spending on intellectual property, an increasingly important asset as the economy becomes digital, rose to $37.7 billion, the highest amount since the end of 2008.

Ultimately, the economy turns on consumption, because household expenditures account for close to 60 per cent of GDP in normal times. Wages and salaries have recovered after their collapse last spring, climbing past their previous peak of about $1.03 trillion. That, combined with emergency COVID-19 benefits, means most households have a decent amount of cash to deploy once economies reopen.

Disposable income rose 2.3 per cent after two consecutive quarterly declines, and the household savings rate rose to 13.1 per cent from 5.1 per cent in the first quarter of 2020. That’s more than enough fuel to power a full recovery from the pandemic, especially if consumers start spreading all that money around, rather than using it to buy houses.

“We should see a rotation in economic activity away from housing and durable goods consumption to the services sector, especially high-contact businesses still reeling from the pandemic,” said Sri Thanabalasingam, an economist at Toronto-Dominion Bank. “This could fuel extraordinary growth this summer.”

Financial Post

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