Were Last Week’s Canadian GDP Data “Atrocious” Or Not?

Last week we received the latest Canadian Gross Domestic Product (GDP) data for January, and economists breathed a sigh of relief when the numbers showed a decline of only 0.1% for the month.

Market watchers had braced for the worst after Bank of Canada (BoC) Governor Poloz warned that growth in the first quarter of 2015 would look “atrocious” thanks to the unfolding oil-price shock. Since Central bankers are not known for hyperbole, when they use a strong adjective, markets take notice. (Merriam Webster’s online dictionary defines the word atrocious as “of very poor quality …  appalling … horrifying”.)

The question that followed the GDP data release was why Governor Poloz used such a strong descriptor to preface the release of a not-so-bad 0.1% GDP decline.

To start with, let’s look at a quick summary of the key concerns raised by Governor Poloz in that widely quoted interview in the Financial Post, which took place on March 30, 2015:

• The BoC believes that the oil-price shock will delay the closing of our output gap until 2017. (As a reminder, the output gap is the difference between our actual output and our maximum potential output. Interest rates would normally be expected to rise at or about the time when the output gap closes.)
• Governor Poloz predicted that, as energy companies cut investment, capital expenditure could fall by as much as ten percent. While he recognized that “lower oil prices mean more money in consumers’ pockets”, he expressed concern that job losses relating to the oil-patch slowdown would create a powerful negative impact that could spread “pretty quickly”.
• The cheaper Loonie is taking longer than normal to boost our exports because many of our export-based companies have shut down since the start of the Great Recession. That means that our export sector must first complete the challenging process of reinventing itself before the full benefits of our more competitive currency can be realized.

After the GDP data release last Tuesday, our main-stream economists lined up to criticize Governor Poloz for what they deemed to be a poor choice of words, calling the result “not as bad as expected”, with one even castigating him to “be a little bit more careful with [his] wording in the future”.

But was this justified? Were market watchers right to breathe a sigh of relief and to upbraid BoC Governor Poloz for a poor choice of words?

When I look beyond the headline number, I am not so sure.

While overall GDP contracted by only 0.1%, a closer look at the numbers heightens my concern. For example, our January GDP growth was supported by a 1.4% growth in the oil and gas extraction sector, which was attributed to oil sands facilities bringing production back online after closing them for maintenance in the fourth quarter of 2014. If oil prices remain at today’s levels, our oil patch should eventually curtail production while continuing to sharply cut new investment. The confluence of these forces should mean that the oil and gas extraction sector would act as a drag on our future GDP growth. Given that, if it took a tailwind in this sector to give us a 0.1% decline in GDP, what happens to our GDP when this momentum reverses into a headwind, as is widely expected?

Also, Governor Poloz has repeatedly said that any sustainable rebound in Canadian GDP growth will need to be fuelled by a rebound in our manufacturing sector and more specifically, in its export-oriented companies. Manufacturing GDP fell by 0.7% in January, and related data for this sector, such as the Purchasing Manager’s Index, indicate that manufacturing-sector momentum continued to decline in February. If a manufacturing renaissance is the key to our long-term economic recovery, the latest data are certainly not encouraging.

Five-year Government of Canada (GoC) bond yields fell by seven basis points last week, closing at 0.73% on Friday. Five-year fixed-rate mortgages are offered in the 2.54% to 2.64% range, and five-year fixed-rate pre-approvals are available at rates as low as 2.69%.

Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.80% range, depending on the terms and conditions that are important to you.

The Bottom Line: Before we get too complacent about our not-so-bad 0.1% decline in January GDP, we should remember that the BoC’s biggest concern for our economy is a sharp slowdown in the oil and gas extraction sector, which actually provided a tailwind for our January GDP data but is likely to change direction, and that the Bank’s biggest hope for our economy is pinned squarely on our still beleaguered manufacturing sector, which continues to show weakness. A GDP forecast that adjusts for these factors might indeed look atrocious.