Canadian economy headed for slowdown

The Canadian economy was firing on all cylinders during the first three months of the year, but that may be as good as it gets for some time.

Statistics Canada’s calculation that the economy advanced by an impressive 3.9 percent in the first quarter of the year nevertheless managed to disappoint, and sent out warning signals of future trouble ahead.

The market reacted by trimming one-tenth of a cent off the value of the dollar, and analysts pointed to glaring chinks in the report.

“It’s not just the headline that matters. It’s the composition of growth that is disconcerting,” said Derek Holt, vice-president of economics with Scotiabank.

The composition of growth was as weak as it could be, with inventory buildup accounting for three quarters of the gains. Without inventories, the economy would have produced a miserable 0.76 percent annualized uptick.

Also worrying is that consumers, the mainstay of the economy during the recession, went into hibernation, contributing only 0.1 percentage points to the advance.

“We’re at all-time highs across so many [consumer spending] variables, and I think that’s a dangerous sign going forward,” Holt added. “Seventy percent home ownership rates, all-time highs in inflation-adjusted consumer spending, record high house prices, record high leverage, record high home-renovation spending. Every single variable one can think of in the household sector is at a record high.”

Some of this had been expected – two months back the Bank of Canada estimated first quarter growth would come in at 4.2 percent and the second quarter would fall to two.

But economists now believe the central bank will be proven as overly optimistic in the second quarter, which ends June 30, as it was in the first, if not more so.

Capital Economics analyst David Madani now sees Canadian growth remaining subdued throughout the rest of the year and next, with 2012 growth being little above one percent.

In part, the weakness in consumer spending reflects the fact that higher energy and particularly gasoline prices are taking a bigger bite out of household budgets, leaving less for other forms of expenditures. That may be temporary, Madani said, but high levels of indebtedness are not and will weigh down purchases going forward.

In a coincidental report, the Canada Mortgage and Housing Corp. predicted this year will see only 179,500 housing starts, compared to 189,930 units in 2010.

The omens are not much better outside Canada, with the re-emergence of the European debt crisis and the Japanese natural and nuclear disasters elevating risks both long-term and near.

In a candid remark Sunday, Finance Minister Jim Flaherty sounded the alarm on a possible global double dip.

“I am quite worried,” he told CTV’s Question Period. “We have lived three-and-a-half years now since the credit crisis started in late August, 2007. We are seeing in Europe, in particular, some very difficult situations.”

The caution somewhat echoes Bank of Canada governor Mark Carney’s assessment in mid-month that the financial crisis is not over.

Given the gathering storm clouds, few doubt Carney will continue to hold steady on rates. Many analysts now see the bank’s one percent policy setting holding steady throughout the summer, if not longer.

“A couple of weeks ago, we pushed back our forecast on the first rate increase to September, and if anything, the risks are that the bank may wait even longer than that,” Bank of Montreal economist Douglas Porter said. Scotiabank’s Holt believes the central bank may stay interest rate hikes until the end of the year.

Last week, several Canadian banks trimmed mortgage rates in another signal that the cost of borrowing will likely remain at very attractive levels for some time.

Monday’s gross domestic product report did contain some bright spots, including March’s advance of 0.3 percent over February, one notch higher than expected.

As well, business investment continued to be a source of strength, rising 13.5 percent on an annualized basis. Housing rose 9.4 percent, but is expected to slow sharply.

Manufacturing, mining and oil-and-gas extraction were significant contributors to growth.

Statistics Canada also made several revisions Monday, upgrading 2010 growth a notch to 3.2 percent, but downgrading 2009 three ticks to a loss of 2.8 percent, making it the second worst year for the Canadian economy in half a century. As well, the agency trimmed growth in the fourth quarter of 2010 to 3.1 percent from 3.3.