GDP growth to trigger fall rate hikes

(July 29, 2005) The Canadian economy continues to growth at a healthy pace, but leading economists say concerns over capacity utilization are expected to lead to interest rate hikes in the fall.

The Canadian economy grew by 0.3% in May while April’s growth was revised downward to match, cutting annualized growth to 2.0%. May’s growth was fuelled by spending in the energy sector and increased investment-related production, according to the latest report from StatsCan.

A 14% increase in oil exploration spending helped boost the resource extraction sector of the economy by 1.7%, while pipeline transportation increased 2.6%.

Construction activity was flat in May, as a 10% increase in non-residential buildings was offset by a 1.8% decline in residential construction. The retail sector slipped 1.1%, hit by weakness in new vehicle sales, which dropped 6.9%. Manufacturing output increased by 0.2%.

“Basically, almost all of the sectors in which there was limited information on beforehand produced robust readings for May, helping spring the upside surprise on overall growth,” wrote Dr. Sherry Cooper, executive vice president, BMO Financial Group.

“Today’s results will simply reinforce the view that the Bank of Canada is poised to begin the rate-hiking process in September,” she said. “However, the tightening cycle certainly looks like it will be very mild, with core inflation still comfortably low at 1.5% and underlying GDP growth struggling to even get to 2.5%.”

RBC Economist Jack Homareau agrees, pointing out that Bank of Canada sees the economy operating at full capacity and may need to reduce monetary stimulus to head off inflation in the future.

“A widely expected resumption of rate hikes signals to the markets that the Bank is forward-looking and serious about keeping inflation under control,” Homareau said.

Also released on Friday was the latest GDP report for the U.S., showing annualized growth of 3.4% in the second quarter, down from 3.8% in Q1.

“The second quarter US GDP figures had two rarities — outright declines in both real imports and real business inventories,” wrote Avery Shenfeld, senior economist, CIBC World Markets.

“A heavy, and likely unwanted, build-up of unsold goods in the winter saw both US and foreign factories cut back on fresh supplies for the American market in Q2. That weighed on GDP growth stateside, but also ate into production activity in Canada, Europe and Asia. It also brought out the ‘on sale’ signs at American malls and car dealers who pushed to clear out the merchandise.”

He suggests that with aggressive inventory liquidation in the second quarter, manufacturers may soon be ramping up production to stock the shelves once more.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com