Canada’s growth surprise affirms rise of services

Bloomberg

Canada’s economy just posted its best quarterly growth in two years. Third-quarter growth of 3.5 percent (at a seasonally adjusted annualized rate) topped the consensus estimate by one tick, and in doing so helped vindicate Bank of Canada Governor Stephen Poloz and his vision for the future of the Canadian economy, which continues to grapple with the impact of subdued commodity prices.
While an expectation that growth would rotate toward exports and business investment remains unfulfilled, the composition of the increase in consumer spending paid testament to the governor’s view that an often overlooked segment of the economy can drive growth.
Household spending on services was a key contributor to growth in the third quarter, adding more than three times what increased spending on consumer goods contributed over the same period. Expenditures on services boosted headline growth by more than household goods consumption some 64 percent of the time over the past 64 quarters.
Poloz had maintained that the enhanced Canada Child Care Benefits program would buoy consumer spending in the third quarter. But more importantly, he recently focused much of his attention on this service side of the economy, devoting a speech on Monday to the topic.
“I strongly believe that the continued expansion of our service sector is pointing the way toward full economic recovery and the return of sustained, natural growth,” he said. Data released by Statistics Canada on Wednesday bested analyst expectations in part due to this segment of the economy.
“Household consumption grew at a 2.6 percent pace, stronger than the trend in real retail sales would have suggested,” noted Nick Exarhos, economist at CIBC Capital Markets.
Three factors make it very difficult for economists to map monthly retail sales onto quarterly consumption figures in the national income and product accounts, said Toronto-Dominion Bank Economist Brian DePratto.
The biggest is that spending on services isn’t included in monthly government data. Also, methods used to adjust for inflation differ between retail sales and quarterly consumption, while certain categories of retail sales (such as building supply stores) are counted in investment, rather than as consumption, in the quarterly data.
“This really underscores the challenges with forecasting, and even more so, with setting monetary policy,” said DePratto. “A lot of these statistical tools that Statistics Canada is producing were developed when our economy had a different composition, and it’s not clear to me that the measurement of services has kept up with their overall growth in the economy.”
For his part, Poloz twice urged the audience in Toronto on Monday to “write to StatsCan” to push for more timely and frequent release of economic data, including statistics related to exports of services. To be sure,
compiling and disseminating service data on a frequent basis may prove a difficult task.
“Capturing services GDP is more challenging,” said Frances Donald, senior economist at Manulife Asset Management. “It’s easy to count how many cars come out on a production line; it’s hard to capture, for example, what a therapist’s or financial adviser’s impact on GDP is.”
While the future of service data is murky, the third-quarter numbers we do have will come as a relief to policymakers who were mulling a rate cut at their October meeting. The figures suggest there is no broad or growing weakness in Canadian consumption, at least at a level that would signal the need for more monetary stimulus (with the side effect of enticing heavily indebted households to add to their fiscal burden).
But if there is a worry to be had on the state of the Canadian consumer, it’s the lack of spending on big-ticket items. Household consumption of durable goods subtracted from growth for the second consecutive quarter—the first time that’s happened in four years. “In large part, this could be capturing the weakness in autos, which is a significant component of durable goods spending,” said David Doyle, analyst at Macquarie Capital Markets. “In Canada, auto sales will decline moving forward, and that would suggest that the durable goods component will be a drag through 2017 and even perhaps 2018.”
The need for increased service activity to offset a drop in durable goods sales would become more acute if the bank is to avoid inching rates closer to its effective lower bound.
“Poloz’s emphasis on services this week suggests the the BoC is taking the implications of a growing service sector for growth and for data seriously,” concluded Manulife’s Donald.