Canada’s Growth Momentum Likely Persisted Near the End of Q2

Momentum Builds Heading into Summer

A closer look at Canada's economic pulse reveals a sustained rhythm of expansion as the second quarter drew to a close. Upcoming releases for June manufacturing and wholesale sales are anticipated to paint a picture of continued real gross domestic product growth, effectively capping a strong three-month period. This positive trend follows a period of softer economic readings over the winter months and offers a welcome counterpoint to earlier concerns.

The Bank of Canada itself has acknowledged the delicate balance of risks facing interest rate policy. In recent communications, policymakers pointed to a dual outlook: the possibility of rate cuts if economic growth falters unexpectedly, contrasted with the risk of hikes driven by inflationary pressures, particularly those stemming from elevated energy prices due to geopolitical tensions.

Wholesale Sector Fuels Expansion

Statistics Canada projects wholesale sales to climb by 2.7% in June. This anticipated rebound follows a sluggish performance in April and May. The driving force behind this projected surge appears to be robust demand for machinery, equipment, and supplies, a trend that aligns with a notable increase in equipment imports from the United States during the same month.

This strength in wholesale trade, combined with an earlier reported 0.4% increase in advance retail sales for June (even with lower gasoline prices) and a pickup in home resales, strongly suggests that Canada's economic momentum remained intact as Q2 concluded. It now appears that quarterly real GDP growth will significantly outpace the previously tracked 2.2% annualized rate.

The nation's economic and employment data have shown marked improvement subsequent to a disappointing Q1 GDP performance. However, the longevity of this Q2 economic vigor remains a subject of scrutiny, with Canada's trade relationship with the U.S. presenting a notable variable due to potential shifts in trade policy.

Inflationary Landscape and Monetary Policy

Despite the encouraging backward-looking data, the path ahead requires careful observation. The concurrent moderation in core inflation this year provides the Bank of Canada with a degree of flexibility. This environment allows the central bank to continue its data-dependent approach, maintaining current interest rate levels without immediate pressure to deviate.

Meanwhile, the Federal Reserve in the United States faces a more complex equation, wrestling with a less balanced trade-off between economic expansion and persistent inflation. While U.S. growth and labor markets have demonstrated remarkable resilience, inflation figures continue to cause concern, increasing the likelihood of further rate adjustments by the Fed.

The upcoming Consumer Price Index (CPI) report for July is poised to be a critical determinant for near-term Federal Reserve decisions. A softer-than-expected CPI reading in June offered a brief respite, enabling policymakers to hold rates steady in July. Nevertheless, a single positive data point does not entirely negate a series of elevated core inflation prints observed earlier in the year.

Our primary forecast anticipates that price increases, excluding volatile energy components, will decelerate sufficiently through the remainder of the year to keep the Federal Reserve on the sidelines through September and the end of 2024. We project headline CPI to moderate to 3.3% in July from 3.5% in the prior month. This forecast is underpinned by an expected slowdown in core inflation (excluding food and gasoline), which we estimate grew by 0.2% on a month-over-month basis in July.

Reading Between the Lines

The latest Canadian economic indicators are painting an optimistic picture, suggesting the economy is navigating choppy waters with surprising adeptness. The anticipated strong finish to Q2, driven by robust wholesale and retail activity, provides a much-needed boost after a softer Q1. This resilience is particularly significant as it occurs against a backdrop of global economic uncertainty and the Bank of Canada's cautious stance on interest rates.

For traders and investors, the persistent growth momentum in Canada offers a counter-narrative to some of the more pessimistic global economic outlooks. The key takeaway is the Bank of Canada's comfort in maintaining its current interest rate policy, supported by both solid growth and contained core inflation. This suggests a period of stability in Canadian monetary policy, allowing businesses and consumers to plan with greater certainty.

Several market connections warrant attention. The strength in Canadian wholesale sales, particularly in machinery and equipment, could signal increased business investment and potentially benefit sectors involved in capital goods manufacturing and distribution. Furthermore, the divergence in monetary policy paths between the Bank of Canada and the Federal Reserve could influence currency markets. Keep a close eye on CAD/USD, as a more stable Canadian outlook compared to a potentially hawkish U.S. Fed could see the loonie strengthen.

Risks remain, however. The sustainability of this growth is intrinsically linked to U.S. trade policy, a factor that introduces an element of volatility. Traders should monitor U.S. trade developments closely. Additionally, while Canadian inflation is subdued, persistent inflation in the U.S. could still exert indirect pressure or influence broader market sentiment. The market will be watching U.S. July CPI data very closely for clues on the Fed's next move, which in turn can impact global risk appetite and commodity prices.