Big Drop in First-Quarter Canadian GDP

The Canadian economy dropped an annualized 5.4% in the first quarter, a deepening in the pace of decline compared to the 3.7% drop in the fourth quarter. On a monthly basis, GDP declined 0.3% in March, which is up from the 0.1% drop in February, but a marked easing from declines of 0.6% and 1% in January and December, respectively. This moderation, along with the sizeable drawdown in inventories, augurs well for the pace of decline in quarterly GDP to ease in the second quarter.

The overall decline resulted from pronounced weakness in business investment that in part reflected the reported 67% annualized decline in pre-tax corporate profits (following a 65% drop in the fourth quarter). Investment in M&E an annualized 35.7%, while non-residential structures were off 14.3%. Residential investment dropped a massive 21%. In total, investment subtracted 5.3 percentage points from first-quarter growth.

The other major contributor to the decline was a massive rundown in inventories that declined for the first time since the second quarter of 2004, resulting in this component subtracting 4.3 percentage points from first-quarter growth. The main offset occurred with net exports adding four percentage points despite a 30.4% drop in exports as imports fell an even greater 37.8%. Consumer spending fell an annualized 1.6%.

The sizeable decline in first-quarter GDP was not unexpected given that the monthly GDP numbers had been showing big declines late last year and early this year as a result of cutbacks in the auto sector. In fact, the Bank of Canada was expecting an even more pronounced drop in the quarter of 7.3% as projected in its April Monetary Policy Report. The central bank will likely be encouraged by indications of a marked lessening in monthly declines in the last two months compared to the end of last year and the start of this year.

As well, the marked first-quarter drawdown in inventories will result in any pick-up in demand more likely to have to be met by new production. This will reinforce the central bank's forecast that the worst of declines will likely occur in the first quarter, with both the rate of decline easing to 3.5% and 1% in the second and third quarters, respectively, and positive growth returning by the fourth quarter.

To ensure that this profile is realized, the Bank of Canada is expected to keep monetary conditions very accommodative, maintaining the overnight rate steady at the current very low rate of 0.25%. Quantitative easing also remains a policy option, though likely only to be invoked in the absence of any marked easing in the pace of economic decline near term.

RBC Financial Group
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The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.