Despite an extremely hostile external economic environment largely caused by uncertainty about the ability of policy makers in Europe to resolve their sovereign debt crisis, and increasing concern about the health of the global economy, growth in Canada rebounded sharply by +3.5% quarter over quarter at annual rates (q/q AR) in the third quarter.
This increase followed a decline of 0.5% q/q AR in the second quarter. In contrast to past upturns in growth which were primarily due to stronger domestic demand, this pickup in activity, which exceeded most analysts’ expectations, was primarily caused by an increase in external demand and specifically by an exceptionally strong (14.4% q/q AR) gain in total exports and a concomitant 3.2% q/q AR decline in total imports.
Looking ahead to 2012, the clouds over the Canadian economy appear to have darkened due to the sharp escalation in the sovereign debt crisis and an apparent deterioration in the health of the European/global economies. Clearly this potential deterioration in external demand poses a serious threat to near term growth in Canada given that trade accounts for one third of overall demand.
However, despite the persisting significant risk of a meltdown in Europe, economic activity in the United States, the market for almost 20% of Canada’s total output appears to be gaining momentum. This is reflected by a gradual strengthening of consumer spending and a moderate improvement in housing demand driven to a significant degree by a stronger pattern of private sector employment growth. Also, business investment has benefitted from very stimulative monetary policy and a solid 14.6% increase in after tax profits.
Over the near term, growth in the U.S. will be driven by the private sector as efforts to reduce the US federal deficit result in cuts to government spending and a possible increase in revenues due to higher taxes.
Following a very small (0.9% q/q AR) gain in the third quarter, domestic demand in Canada should accelerate over the near term and through 2012 due to stronger consumer spending, sustained residential construction and a moderate strengthening of business investment. Key to the strength of consumer spending is the fact that over the past year the economy has added 273,000 full time jobs. Also, despite a recent pause in job growth in October and November and the persisting concern about the European sovereign debt crisis, consumer confidence exhibited a healthy gain in November.
Over the near term, the fundamental drivers of housing demand (low interest rates, stronger full time employment and strong confidence) remain positive. However, higher prices in a number of major markets plus some cooling in foreign investment in real estate are likely to cause the pace of new construction to moderate over the next several quarters following an unsustainably strong gain in the third quarter.
Despite the heightened concern about Europe’s sovereign debt crisis, the outlook for business investment remains positive due to the recent pickup in corporate profits, a healthy increase in industrial capacity utilization and persisting, strong investment plans in new machinery and equipment. This positive investment outlook was recently reinforced by announcements of major investment projects by Suncor to proceed with the Joslyn oil sands project and by Rio Tinto to complete the modernization of the Kitimat smelter in British Columbia.
Following an estimated gain of 2.4% in 2011, growth in Canada should average in the range of 2.3% to 2.8% in 2012 and by 2.8% to 3.2% in 2013 driven by a moderate strengthening of domestic demand and an accompanying gradual improvement in external demand.