Canada: Q2 Economic Indicators Review

– In June, manufacturing shipments fell 0.4% in nominal terms after staying flat in May (revised up from -0.4%). More important for GDP, they rose 0.1% in volume terms after climbing an upwardly revised 0.65% the month before. The ratio of real inventory to shipments slipped to a three-month low of 1.35. Following the upward revisions to the May figures, shipment volumes grew at an annualized pace of 5.8% in Q2 after pulling back 3.8% in Q1. The performance in Q2 was attributable primarily to strong auto shipments spurred by strong U.S. vehicle sales. The drop in the inventory-to-shipments ratio should lend some support to production in Q3.

In July, Canada’s consumer price index dipped 0.1%, confounding consensus expectations for a 0.2% increase. The CPI sagged 0.1% in seasonally adjusted terms as well, with prices moving lower in three of the eight broad CPI categories: health/personal care (-0.1%), clothing/footwear (-0.9%), and transportation (-0.6%). These more than offset higher prices for alcohol/beverages, household operations, shelter and food.

Recreation/education prices held steady. The year-on- year inflation rate dropped to 1.3%, two ticks below consensus expectations. Core CPI slid 0.1% but was level in seasonally adjusted terms. This caused the year-onyear core inflation rate to slide three ticks to 1.7%, its lowest mark since July 2011, and well below consensus expectations. In the past three months, core inflation has run at an annualized -0.3%, its lowest pace since 2007.

If we apply the same definition of core inflation as used in the United States (CPI excluding food and energy), the picture becomes even more deflationary with an annualized price decrease of 1.7% over that period. Such a trend had not been observed in Canada since 1994. Weakness was widespread with larger-than-usual price declines in clothing/footwear, health/personal care and vehicles since April. However, the recent situation seems overdone in the light of economic fundamentals.

Consequently, we expect core inflation to strengthen somewhat in the months ahead. Also, the recent surge in grain and gasoline prices will ultimately push up headline inflation. All in all, given the current concerns about the global economy and the tame inflation backdrop in Canada, the Bank of Canada’s tightening bias is looking more and more untenable. Indeed, even if we assume core inflation will tick up in the following months, it will average no more than 1.5% in Q3, which is well shy of the BoC's 1.9% estimate for the quarter.

United States – In July, retail sales rose 0.8%, more than double what was expected by consensus. However, the prior month’s figure was revised down two ticks to -0.7%. Sales of autos and parts swelled 0.8%. Excluding this category, retail sales still rose a strong 0.8%, well above consensus expectations. Gasoline sales, for their part, were up 0.5%. Excluding autos and gas, retail sales sprang 0.9% on broad-based strength, including in housing-related segments such as building materials (+1%) and furniture (+1.1%).

Discretionary spending (i.e., retail sales excluding gasoline, groceries, and health/personal care) advanced 0.9% as consumers apparently took advantage of end-of-summer clearance sales. Looking forward, growth in consumer spending will depend on whether the labour market can maintain momentum. Indeed, though July's consumption results were good, our outlook remains cautious because employment could be affected in coming months by the weakness in goods orders.

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