Canada on the verge of a recession: Davenport

Key Concepts

• GDP (Gross Domestic Product): A measure of the total value of goods and services produced in a country over a specific period.
• Transportation and Warehousing Sector: Industries involved in the movement and storage of goods.
• Goods Producing Sectors: Industries that produce physical goods, such as agriculture, mining, construction, and manufacturing.
• Trade Sensitive Sectors: Industries heavily influenced by international trade, including manufacturing, wholesale trade, and transportation.
• US Tariffs: Taxes imposed by the United States on imported goods, impacting international trade.
• Trade Policy Uncertainty: A state of unpredictability regarding trade regulations and agreements, affecting business investment and planning.
• Utilities Sector: Industries providing essential services like electricity, gas, and water.
• Retail Trade Sector: Businesses involved in selling goods directly to consumers.
• GST Holiday: A temporary reduction or elimination of the Goods and Services Tax.
• Bank of Canada: Canada's central bank, responsible for monetary policy.
• Policy Rate: The interest rate set by the central bank, influencing borrowing costs and economic activity.
• Inflation: A general increase in prices and a fall in the purchasing value of money.
• Technical Recession: Typically defined as two consecutive quarters of negative GDP growth.
• Monetary Policy: Actions undertaken by a central bank to manipulate the money supply and credit conditions to stimulate or restrain economic activity.
• Basis Point: A unit of measure equal to one-hundredth of a percent (0.01%).

Summary of GDP Results for August

This summary details the release of Canada's Gross Domestic Product (GDP) results for August, highlighting a slight decline driven primarily by contractions in the transportation and warehousing sector. Michael Davenport, senior economist at Oxford Economics, provides analysis on these results and their implications for the Canadian economy.

August GDP Performance and Expectations

• Overall Decline: Canada's GDP fell by 0.3% month-over-month between July and August.
• Expectations vs. Reality: This decline was slightly below the consensus estimate, which generally predicted zero growth. Stats Canada's flash estimate was 0.4% growth. Oxford Economics had a more downbeat forecast, anticipating growth slightly below the consensus.
• Second Half Outlook: Davenport's view is that the Canadian economy will struggle to grow on an aggregate basis in the second half of the year, a trend now appearing in the data.

Sectoral Analysis of GDP Decline

Goods Producing Sectors

• Broad-Based Contraction: Overall output in goods producing sectors fell by approximately 0.6% month-over-month.
• Specific Industries:
  • Agriculture, Forestry, Fishing, Hunting: This was the only sector that did not contract, experiencing no growth.
  • Mining, Quarrying, Oil and Gas Extraction: Saw contractions.
  • Construction: Experienced contractions.
• Trade Sensitive Sectors: These sectors were a significant drag on the economy in August.
  • Manufacturing Output: Pulled back after a rise in July, resuming a downward trend observed since the beginning of the year.
  • Wholesale Trade: Another highly trade-exposed sector that contracted in August.

Transportation and Warehousing Sector

• Decline: This sector also fell in August.
• Contributing Factor: A significant contributor was the Air Canada flight attendant strike mid-month.
• Expected Rebound: The strike was resolved, and a rebound in this sector is anticipated for September.

Utilities Sector

• Largest Contraction: Utilities experienced the largest contraction of any industry, falling by 2.3% month-over-month.
• Stats Canada Attribution: Attributed to drought conditions.
• Underlying Weakness: Davenport notes that the trend in utilities has been weak, reaching its lowest level since May 2018 in August. This weakness is likely tied to the broader decline in goods producing sectors, as these sectors consume significant energy.

Trade Sectors and Future Outlook

• Expected Drop: The contraction in trade sectors was not surprising, given earlier data on manufactured and wholesale sales.
• Impact of US Tariffs: Davenport argues that trade-sensitive sectors will continue to be heavily impacted by US tariffs and pervasive trade policy uncertainty.
• Consequences: This uncertainty is limiting output for firms in manufacturing, wholesale trade, and transportation, and is also hindering investment and hiring in these sectors.
• Long-Term Forecast: As long as significant US tariffs remain, the economy is expected to struggle to grow in the second half of this year and into early 2026, remaining on the precipice of a potential recession.

Utilities Sector: Beyond Drought

• Drought as a Factor: While drought contributed to the August drop, the overall trend in utilities has been weak.
• Link to Industrial Production: The decline is likely connected to the broader weakness in goods producing sectors, which are significant energy consumers. Declines in industrial production over recent months have naturally led to a follow-on effect in the utility sector.

Positive Developments: Retail Trade Sector

• Rebound: The retail trade sector showed a positive rebound, with output increasing by 0.9% month-over-month.
• Offsetting July Decline: This rebound partially offsets a significant decline in July.
• Trend Analysis: Despite the August increase, overall retail spending has shown little growth since December 2024, when it was temporarily boosted by a GST holiday.
• Future Headwinds: Several headwinds are expected to affect the retail sector moving forward, including slower population growth and a weakening labor market, which could impact consumer spending.

Interest Rates and Recession Prospects

• Bank of Canada's Stance: The Bank of Canada recently lowered its policy rate but signaled that it is likely done cutting rates for this cycle.
• Balancing Act: The central bank is balancing upside pressures on inflation against downside pressures on demand stemming from tariffs and trade wars.
• Monetary Policy Limitations: Davenport emphasizes that monetary policy is not the appropriate tool to address structural economic shifts like those caused by US trade policy and global supply chain reorganization.
• Recession Odds: The weaker GDP report for August increases the odds of a technical recession through the middle of this year.
• Potential for Further Cuts: Continued weakness in GDP growth and the labor market could lead to one or two additional 25 basis point cuts by the Bank of Canada early next year.
• Base Case: However, the base case forecast is that the Bank of Canada will remain on hold for the foreseeable future.

Conclusion

The August GDP results indicate a slight contraction in the Canadian economy, primarily driven by declines in goods-producing and trade-sensitive sectors, exacerbated by US tariffs and trade policy uncertainty. While the transportation sector is expected to rebound, the utilities sector shows underlying weakness. The retail sector experienced a positive rebound, but faces future headwinds. The Bank of Canada has signaled a pause in interest rate cuts, despite the increased risk of a technical recession, suggesting a focus on addressing inflation while acknowledging the structural challenges facing the economy.