MONTREAL, Canada – As we enter the final quarter of the year, the Canadian economy faces mounting challenges due to persistently high interest rates impacting households and businesses alike. Following a sluggish third quarter, the economy is projected to remain stagnant in the coming months.
After experiencing no growth in June, the economy saw a slight increase in July, with a real GDP growth of +0.2%. Both goods and services sectors contributed to this modest gain, with the retail sector emerging as the primary driver, recording its largest monthly increase in over 18 months at +1.0 percent.
Statistics Canada anticipates another month of neutral growth for August. If realized, this performance would demonstrate resilience amid Canada’s ongoing economic slowdown.
Households Reduce Debt
The return to robust economic growth heavily relies on household spending, which constitutes 60% of GDP. Despite cuts to interest rates by the Bank of Canada since June, borrowing costs remain notably high, prompting consumers to exercise caution in their spending habits.
However, household debt as a proportion of disposable income decreased to 175.5 in the second quarter, marking the lowest level since early 2021. This shift indicates that income growth is outpacing debt accumulation, a positive sign for the Canadian economy, suggesting a reduced reliance on consumer credit.
Further interest rate cuts are unlikely to spur excessive borrowing in the latter half of the year due to still restrictive rates. The rise in the savings rate during the second quarter further illustrates consumer reticence regarding spending.
Inflation Stabilizes
The Bank of Canada received encouraging news in its recent inflation report, highlighting a decline in headline inflation, measured by the Consumer Price Index (CPI), which fell to 1.6 percent in September, below the 2.0 percent target. Core inflation measures also registered significant decreases compared to August.
This shift opens the door to potential interest rate cuts. Although the economic slowdown is pronounced, it is not alarming to the Bank of Canada, leading us to expect a reduction of 25 basis points in the key rate during the upcoming October meeting, though larger cuts could also be warranted.
Unemployment Rates Decrease
The unemployment rate dropped to 6.5 percent in September, marking the first decline of the year. Job creation has remained relatively flat since May but surged in September, with 47,000 jobs added compared to 22,000 the previous month. Notably, employment gains were predominantly in the private sector (+61,000), indicating a gradual recovery among businesses.
Overall job creation since the beginning of 2024 stands at 257,500, yet the unemployment rate has consistently increased until the recent decline in September, a result of a rising labor pool. Hiring challenges are expected to persist as labor supply continues to grow.
Job vacancies dropped to just over half a million in July, nearly half the peak observed in May 2022, while retirements remained elevated at 310,400 in August.
Business Implications
- Consumers will likely remain cautious, postponing large purchases or opting for substitute products. Businesses should focus on enhancing the value of their offerings to sustain sales and ensure effective inventory management.
- With interest rates expected to continue declining, it is an opportune moment for businesses to reassess growth strategies and medium-term development plans in light of a potential economic rebound.
- The economic slowdown persists, making it crucial for businesses to implement sound financial practices and adjust strategies in anticipation of evolving market conditions.
US Economy Maintains Momentum
The US economy continues to show signs of health, with indicators suggesting a soft landing. At its September meeting, the Federal Reserve opted for a 50 basis point rate cut, reflecting a consensus among economists though opinions varied on the scale of the cut.
Despite high interest rates, consumer and business spending remains strong, although weakening labor market conditions raised concerns. However, the job market rebounded in September with the creation of 254,000 jobs, while revisions showed average monthly job gains at 186,000 for the third quarter.
US economic growth remains robust, having expanded by 3.0 percent in the second quarter, driven by consumer spending and investment. The target range for the federal funds rate is now between 4.75 – 5.0 percent, with most Federal Open Market Committee participants supporting further rate cuts by the end of 2024.
Consumer Spending Resilience
American consumers are actively spending, contributing to sustained economic growth in the third quarter. Personal consumption expenditures rose by 0.1 percent in August, with spending outpacing disposable income during the initial months of the quarter.
US savings have declined consistently since May, reaching a low of 4.8 percent of disposable income in August. This trend suggests continued consumer spending despite challenges.
Strong Job Market
The job market’s resurgence in September alleviates fears of a significant employment slowdown. Unemployment remains low at 4.1 percent, and job vacancies increased to 4.8 percent in August, highlighting ongoing demand for labor.
Core Inflation Stabilizes
August inflation, as measured by the Personal Consumption Expenditure (PCE) price index, stood at 2.2 percent, with core inflation remaining at 2.7 percent when excluding food and energy. Despite declines in the overall PCE index, core inflation has stagnated above target, indicating that the Federal Reserve may temper the pace of future rate cuts.
Business Considerations
- Decreasing US interest rates will influence the Canadian economy. Canadian borrowers in US dollars could benefit from lower costs, including banks borrowing on the wholesale market.
- With the US job market improving and consumer spending robust, Canadian exporters may find favorable conditions for growth.
- The loonie may depreciate against the US dollar due to the widening interest rate differential, impacting trade dynamics for Canadian businesses and increasing costs for imported goods.
