Canada: Less Economic Slack Supports a 25-Basis Point Rate Cut in December

Canadian GDP growth might have come in close to expectations but Canada’s economic engine is not exactly in fine shape. First, business investment declined following lower spending on aircraft and ships, which coincided with a drop in imports of those same goods in the quarter. When combined with another drop in export volumes, net exports were a drag on Q3 growth. In contrast, residential investment grew modestly, driven by higher resale activity. Meanwhile, consumption saw strength across all categories, especially in durable goods thanks to auto sales. Government consumption also rose for a third consecutive quarter with higher spending across all levels of government (graph 1). In other news, corporate incomes dropped due to losses in manufacturing, wholesale, and retail sectors. Compensation of employees made another solid advance this quarter (7.1% annualized). This allowed the savings rate to accelerate to an elevated 7.1% from 6.2% in Q2, although the average savings rate over the past three years was revised down by 1.5 percentage points.

But maybe the most important change for the Bank is the historical upgrade in the level of real GDP. This led to an upward revision in our output gap estimate of about 0.5 percentage points in Q2 2024, to -0.8% from -1.3%. Our output gap estimate is now markedly less negative than the Bank’s estimate of -1.2% in its October 2024 Monetary Policy Report (MPR), and suggests there is less slack in the Canadian economy than previously assumed (graph 2). This reinforces our call for a 25-basis point rate cut at the Bank of Canada next meeting, as opposed to 50-basis points.

We’re currently tracking annualized real GDP growth in the range of 1.5% to 2.0% in Q4, which is a modestly slower pace than the Bank of Canada’s 2.0% forecast. And despite upward revisions, real GDP per capita numbers continue to fall (graph 3). Indeed, a third consecutive month of job gains in October External link. wasn’t enough to offset population growth that is still outpacing labour demand. This contributed to ongoing signs that the labour market is cooling. Furthermore, the economy faces significant headwinds from the impending mortgage renewal wall and slower population growth. Lastly, the threat of tariffs from the second Trump administration adds a great degree of uncertainty and compounds the downside risks to growth and inflation External link.. Consequently, we expect the Bank to proceed with an additional five cuts in 2025 to counteract the downward pressures to their economic outlook.