Posted Thursday December 27, 2018

GDP & Retail Sales

Economy perks up in October, but consumers remain cautious

GDP beat expectations in October, even as retail sales came in weaker than anticipated; The economy had a bit more momentum than expected at the start of Q4, but still looks on pace to expand by 1.3%; The weak retail sales data suggest that households are responding to higher rates and rising debt service costs

GDP rose by 0.3% m-o-m in October. This was above the consensus expectation of a gain of 0.2%. Even with the upside surprise, GDP growth was as expected at 2.2% y-o-y. In the month there were 0.3% gains among both goods-producing industries and services-producing industries.

Gains on the goods-producing side of the economy were led by utilities, and manufacturing. These offset a weak reading on agriculture, and a small decline in construction. The 0.7% increase in manufacturing was a bit of a surprise given that the preliminary manufacturing report indicated a gain closer to 0.2%. Though there were many positives in the GDP report, we would note that construction activity has declined for five straight months.

On the services side of the economy, the increase in activity was led by finance and insurance, and wholesale trade. These gains more than offset a modest decline in transportation and warehousing. Statistics Canada noted that activity in bond and money markets and "unseasonal" stock market activity helped boost the finance and insurance sector. In October, Canada's main equity benchmark, the S&P TSX, fell by 6.5%, while 10-year bond yields fell by 20 basis points from a high of 2.6% early in the month.

Though GDP surprised to the high side, retail sales surprised to the low side in October. Headline retail sales rose by 0.3% m-o-m (cons: 0.5%), while sales excluding autos were flat versus an expected 0.2% gain. In the month, the increase in sales was due to higher prices. In real terms, retail sales were effectively flat.


Though GDP surprised to the high side in October, we continue to forecast Q4 GDP growth of 1.3%. There are two reasons for this. First, to reach 1.3%, we would still need to see small gains in economic activity in November and December. While this still seems the most likely scenario, it is far from certain given the intensified pressure on the oil sector in late October and early November. Though the downward pressure in the oil patch prompted the Alberta Provincial Government to announce mandated production cuts starting in January 2019, industry reports suggest that activity has already begun to decline toward year end.

Second, some of the larger gains in October could be reversed in November. For example, wholesale trade rose by 1.0% in October, but the average gain over the past year is 0.2% per month. Similarly though finance and insurance rose by 0.9% in October, the average gain is also 0.2% per month. Meanwhile, in November, the S&P TSX was largely flat suggesting that activity might decline relative to October. With some potential for changes in November to offset some of the gains in October, we continue to look for modest GDP growth of 1.3% in Q4.

Today's retail sales report might be overshadowed by the GDP report, but there are still some developments in the retail sales figures that we think are worth keeping track of. One interesting development is that even though auto sales have increased in the past few months, much of the increase has been in used cars. Higher rates might be resulting in less costly auto purchases that require a smaller amount of borrowing.

Another interesting development was the 1.8% m-o-m increase in service station sales, even though the October CPI report indicated that gasoline prices dropped by 3.2%. We had thought that the drop in gasoline prices would ease the pressure of the high cost of fuel on households, allowing for increased sales activity elsewhere. Instead, sales of gasoline rose. As a result, retail sales excluding autos and gasoline fell by 0.4%, the largest decline since December 2017. With gasoline prices down by almost 10% in November, and with the household savings rate near 1% of disposable income, we will pay close attention to how households respond. Households could use the decline in gasoline prices to increase spending on other goods and services, or they could increase savings and attempt to offset their exposure to rising interest rates.

In our view, the retail sales report is consistent with our forecast for modest consumer spending growth, in part, reflecting the impact of higher interest rates on interest-sensitive spending, and the ability of some households to manage rising debt service costs.

by David Watt Chief Economist, HSBC Canada

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ISSN 0824-45
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