Canadian economy avoids slowdown in May, economists expect continued contraction

The Canadian economy stayed flat in May, with growth slowing down as businesses continue to face supply constraints and rising interest rates, though economists say the current cycle of interest rate increases is expected to continue into the fall.

Real gross domestic product was unchanged in May after a 0.3 per cent expansion in April, Statistics Canada reported Friday.

Growth in services-producing industries was offset by a decline in goods-producing industries, the federal agency said.

RBC assistant chief economist Nathan Janzen said the economy is hitting long-term production capacity constraints, in part because of the ongoing labour shortage.

"We're expecting growth to slow, but part of the reason for that is because the economy right now is incredibly strong," Janzen said, noting that the economic recovery from the pandemic was much faster than expected.

A preliminary estimate for second-quarter GDP points to 4.6 per cent annualized growth, up from 3.1 per cent for the three months of the year.

After taking a significant hit at the onset of the pandemic, real GDP surpassed the pre-pandemic level in November 2021.

"We've reached a very strong point in the economic cycle, earlier than expected. But the challenge from there [is] it's just not sustainable," he said.

The strength of the Canadian economy will have implications on the Bank of Canada’s next key interest rate decision, as it aims to cool high inflation.

Earlier this month, the central bank raised its key interest rate by a full percentage point, the largest single rate hike in more than 20 years.

CIBC senior economist Andrew Grantham said solid annualized growth in the second quarter means the Bank of Canada will likely go ahead with another supersized rate hike in September.

"That solid growth, combined with the details of today's data which suggests supply constraints, rather than slowing demand, were holding back overall growth, means that the Bank of Canada is still on course to deliver another non-standard rate hike at its next meeting,” Grantham said in an email.

The Bank of Canada will make its next interest rate announcement on Sept. 7.

RBC is forecasting two consecutive quarters of negative growth next year, which would meet the definition of a technical recession. However, Janzen said the downturn is likely to be moderate and given early signs that global pressures on inflation are easing, the Bank of Canada may start reversing rate hikes next year.

With the inflation rate at a 39-year-high of 8.1 per cent, the central bank said it will continue to raise the cost of borrowing to decrease demand in the economy, hoping it can bring down inflation without triggering a recession.

Janzen said he expects a half-percentage point rate hike in September, with the Bank of Canada eventually bringing its key interest to a high of 3.25 per cent before it starts reversing its rate hikes.

According to the report released on Friday, the largest declines in May were experienced in the construction and manufacturing sectors, while transportation and warehousing saw the largest gains.

Statistics Canada said construction worker strikes in Ontario during May led to delays in projects. However, construction activity remained well above pre-pandemic levels.

Manufacturing contracted for the first time in eight months, with motor vehicle manufacturing stalled by a semiconductor chip shortage.

Transportation gains were driven by growth in air travel, which rose by 14.1 per cent.

The results are better than expected. StatCan's preliminary estimate suggested the economy contracted by 0.2 per cent in May.

On Thursday, the U.S. Commerce Department said the U.S. economy contracted for a second consecutive quarter, but CIBC economists expect growth to bounce back over the remainder of the year.

This report by The Canadian Press was first published July 29, 2022.