With Canadian GDP numbers being released on Thursday, economists were surprised with the relative strength seen in monthly estimates as real GDP in January grew by 0.6%. This is the fourth consecutive monthly increase following a difficult 2015 which hurt growth estimates due to the lower price of oil. Canada was previously in a recessionary environment for the first half of 2015 as Q1 and Q2 GDP came in at -0.2% and -0.1%. This poor economic performance was due to the declines in oil and the weaker Canadian dollar as the services and financial sector saw investor confidence decline. While the lower dollar may impact consumer purchasing power, the country remains a major exporter to the United States and directly benefits from this currency advantage as its export account has seen a direct increase due to positive currency conversion effects. After evaluating the GDP growth numbers, there are three major factors behind the improved economic performance in the economy which should also provide a useful outlook for Canadian growth.
Canadian Dollar Weakness
In the past two years, the Canadian Dollar has declined by 14.83% relative to the USD as global investors lost confidence in Canadian growth prospects following the collapse in oil. For Canada, the country is a major commodity producer and the decline in commodity prices has impacted output and employment numbers throughout the country. Unfortunately, with the decline in oil, the nation has seen unemployment go up from 6.6% to 7.4% while GDP numbers in 2015 reported quarterly declines for Q1 and Q2 respectively. Provided these worsening conditions, the Canadian dollar reached record lows over the past few months and increased pressure on Canadian consumers as their spending power declined. However with this decline, Canadian exporters have actually benefited as their products become much cheaper for US importers relative to other global producers. Therefore, looking at the numbers, the market has finally begun to react to these new conditions as GDP directly benefited from increased exports. Trade volumes reported a 3.6% increase while the overall value of exports increased by 1% in the past month. Looking at Canada's trade relationship with the United States, 73% of the country's exports are directly sent to the US which illustrates just how quickly a lower Canadian dollar will impact the country's trade account.
Manufacturing Sector Strength
^Sourced from Stats Canada
Building off the weaker Canadian dollar, the manufacturing sector saw a 1.9% gain in monthly output as sales continued their consecutive six month increase since October of 2015. With the weaker Canadian dollar and increased exports, domestic manufacturers have taken advantage of the cheaper currency and increased both output and sales in order to compete with global manufacturers. Following a 2015 period where the sector's results were extremely volatile, the effects of the lower dollar have begun to translate into consistently higher output numbers in the past three months. Delving into the 1.9% increase in manufacturing output, the lower interest rate environment in Canada has stimulated production numbers for automotive and retail sales, two of the three biggest sectors in Canada. New vehicle sales grew by 9.2% yoy following a poor performance in 2015 as consumers were able to access credit at a much cheaper rate. In addition, the overall retail trade account grew by 2.1% mom which was supported by growth in furniture (10.9%) and motor vehicles/parts (15.7%) sales. The manufacturing output in the past month and over the past year has been strong and the primary drivers of this growth remain the low Canadian dollar in addition to favorable monetary policy as capital invested provided added returns for manufacturers.
^Sourced from Trading Economics
One of the more indirect factors impacting the recent strength in GDP has been the Bank of Canada's (BoC) monetary policy which saw interest rates cut to 0.5% in July of 2015 following a downwards revision in growth estimates. The reasoning behind this move was to increase consumer confidence following a poor first half of 2015 which saw consumer demand and investor confidence continue to fall. As with many other major economies, the lowering of interest rates impacted the cost of credit which directly saw retail sales increase by 6.4% yoy as Canadians were able to spend more and increase their credit purchases. Another major benefactor of lower interest rates which has driven economic output is Canada's housing sector which saw national home sales rise by 0.8% mom while total sales volume was up 18.7% as a result of this increase in confidence. The housing market is the bedrock for the Canadian economy accounting for 20 to 30% of total economic activity and lower interest rates will directly improve the sector's contribution to economic growth. Looking into the medium-term, the BoC finds itself in a much better position as the strength in GDP signals that an interest rate cut in 2016 is not necessary under current conditions. This stabilization in investor confidence should translate to a much calmer market in 2016 as the Canadian economy deals with this lower credit environment.
With January's growth coming in at twice the expected rate, the 0.6% growth has been a positive sign as the economy recovers from a recessionary environment in 2015. It seems that majority of the pressures which previously worried domestic investors have reversed and driven a more positive response from the economy as the low interest rate environment has translated to higher economic output. In the current environment, the Canadian Dollar remains linked to the price of oil thus the outlook for the currency remains poor. In addition, the continued strength in the US dollar will drive the relationship between the USD/CAD much wider as both countries deal with the realities of a lower price of oil. However, even with a lower Canadian dollar, GDP numbers are expected to remain in a positive range with the 0.6% increase seen in January at the top end of this growth spectrum. If US import demand continues to perform and support the trade numbers seen between the two countries, the major driver of economic growth for Canada in the following months will remain exports and the related benefits to manufacturers. Overall, in the current market, the Canadian economy has been upgraded from a sell grading in the past year to a hold level in the current market.
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