Canada's economy experienced a sharp contraction in the latest quarter, primarily due to a decrease in exports and a sluggish buildup of inventories among businesses. According to data released by Statistics Canada on Thursday, gross domestic product (GDP) declined at an annualized rate of 1.1% over the three-month period. This represents a significant decline compared to the revised 1.4% growth observed in the second quarter, which initially had been estimated as a 0.2% contraction.

This downturn marks the first since the previous year's final quarter and stands as the largest decline in GDP since the second quarter of 2021, when the pandemic was at its peak. Economists had expected a modest 0.1% quarter-on-quarter increase, while the Bank of Canada had forecasted a more optimistic 0.8% growth. However, this contraction underscores the indicators pointing toward a more subdued economy following a series of interest rate increases aimed at addressing inflation concerns.

This weakening trend is likely to solidify expectations in the market that the central bank has concluded its aggressive interest rate-raising campaign. Over the course of 16 months, the policy rate has surged from 0.25% to 5%, with back-to-back increases taking place in June and July.

The decline in quarterly GDP was primarily driven by a drop in exports, particularly in refined petroleum product shipments, following a substantial increase in the previous quarter. Furthermore, the economy was also impacted by the smallest buildup of inventories since the third quarter of 2021, as manufacturers recorded shrinking inventories after six straight months of growth.

While data for September reveals a 0.1% increase in industry-level GDP compared to the previous month, slightly higher than the advance estimate indicating an essentially unchanged figure, early data for October suggests a modest 0.2% increase from September. This provides a cautiously optimistic start to the final quarter of the year, despite signs of slowing employment growth and a rising jobless rate.

The Current State of the Canadian Economy

The Bank of Canada has made progress in bringing consumer inflation back to its 2% target, although it has been a slow process. However, there has been a significant easing from the peak experienced in the middle of last year. The bank predicts that GDP will remain modest throughout most of 2024, hovering just below 1%. Despite this, the housing market, which was once a driving force behind Canada's economic growth, has started to struggle in recent months after experiencing a recovery earlier in the year. Central bank officials have observed that the economy is approaching a state of balance, and pricing behavior within corporations is beginning to normalize.

While there are concerns among some economists that the economy may still be at risk of slipping into a shallow recession due to the lingering effects of past rate increases, others highlight the relative resilience of Canada. Despite facing various challenges such as higher borrowing costs, forest fires, and strikes that have disrupted trade, Canada has yet to experience consecutive quarterly contractions.

In the third quarter, there was an increase in housing investment for the first time since early 2022. This was attributed to growth in new construction, which offset a decline in ownership transfer costs—an indicator of resale activity—according to Statistics Canada. Additionally, employee compensation rose during this period due to an increase in average earnings and employment. The household savings rate also saw a modest gain in disposable income.

However, household spending remained stagnant for the second consecutive quarter, and business investment in non-residential construction and machinery/equipment decreased.

Final domestic demand, which serves as a measure of spending across all sectors of the economy, remained steady at a nonannualized rate during these three months.

Statistics Canada's advance estimate for October suggests a 0.2% rise in industry-level GDP. This increase is expected to be driven by growth in mining, quarrying, oil and gas extraction, retail trade, and construction. However, the estimate also predicts a decline in wholesale trade.

The slight increase in GDP in September was supported by a rebound in manufacturing following three consecutive months of decline. Construction activity also continued to show gains. However, these positive factors were partially offset by a decrease in oil and gas extraction due to maintenance activities at several facilities nationwide, as well as a decline in metal-ore mining.

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