Canadian economy and inflation outlook
Governing Council members then discussed recent data on economic activity and inflation in Canada. They acknowledged that recent data were mixed. On one hand, there were encouraging indications that monetary policy easing had begun to translate to higher household spending. On the other hand, overall growth was weaker than expected and the labour market had continued to soften. Members discussed the mixed data in some detail and assessed the implications for the economic outlook.
National Accounts data for the third quarter showed the economy grew at 1%. This was lower than expected in the October Report. But there were clear areas of strength. Members noted that consumption grew by almost 3½%, surpassing expectations. Consumption per capita rose by 0.6% in the third quarter after declining in six of the last eight quarters.
Retail sales were also stronger than expected in September, thanks in part to a boost in motor vehicle sales. This momentum appears to be continuing into the fourth quarter. Housing resale activity also picked up across the country. Members noted that lower interest rates, combined with new mortgage rules coming into force in December, could be expected to further increase housing market activity.
Other components of the third-quarter data were weak. Business investment was considerably weaker than anticipated and contracted by about 7½%. The drop was mainly driven by a large pullback in investment in manufacturing and equipment, in part due to volatility in the aircraft and transportation equipment subcomponent. Members expressed concern that the uncertainty created by the incoming US administration’s threat to impose tariffs on Canadian exports would weigh on the investment climate. Exports also declined in the third quarter, although energy exports were up due to increased shipments through the Trans Mountain Expansion pipeline.
Historical revisions to the National Accounts data showed the level of gross domestic product (GDP) was more than 1% higher than previously reported. Upward revisions were broad-based across GDP components, with consumption and investment the biggest contributors.
Members discussed the recent changes to immigration targets. They agreed that the planned reductions in immigration will translate into lower GDP growth than the Bank had forecast in the October Report, with lower aggregate consumption and less demand for housing. Outreach with small businesses and other regional intelligence suggested the adjustment to sharply lower immigration levels could be difficult for companies that have had challenges recruiting and retaining workers. More broadly, lower population growth would affect both supply and demand in the economy, suggesting less impact on the inflation outlook. Members agreed that further analysis would be needed to assess the likely timing of the demand and supply effects of new immigration targets as part of the preparation of the updated forecast in January.
Labour Force Survey (LFS) data from November showed an increase in employment, but it continued to grow more slowly than the labour force. In November, the participation rate increased significantly, which led to an increase in the unemployment rate to 6.8%. Wage growth also declined in the November LFS survey, but was still elevated relative to productivity growth. Members were cautious about putting too much weight on one month of data, but they agreed that slack in the labour market had continued to increase.
Consumer price index (CPI) data for October indicated that inflation had been evolving in line with expectations. After dropping to 1.6% in September, total CPI inflation rose to 2.0% in October, largely due to less prominent base-year effects from gasoline. Members largely attributed the recent uptick in core measures of inflation to recent volatility in certain goods and services prices. Recent policy measures, particularly the temporary suspension of the GST on some items, could cause short-term volatility in inflation. Members agreed they needed to look through the temporary effects of these measures and focus on the trend of underlying inflation.
Members noted that downward pressure on inflation from goods prices had moderated as these were no longer declining overall. Upward pressure from elevated services price inflation had also moderated, including slower increases in rent and mortgage interest costs. Members agreed that the opposing forces pushing inflation down and pulling it up had both been moderating constructively. Members expected this dynamic to continue in the months ahead and keep inflation close to the target, but there were risks on both sides.
Governing Council members reflected on these upside and downside risks to the inflation outlook. Upward pressure on services prices could resume if wage growth remained elevated relative to productivity. A bigger-than-expected pickup in the housing market could also push shelter costs higher. On the downside, inflation could fall below target if slower growth leads to more sustained slack in the economy.
In addition to these risks, a major new source of uncertainty was the possibility that the incoming US administration would impose tariffs on Canadian exports to the United States. The impact on economic activity and inflation would depend on several factors, including the scope and size of the tariffs and any retaliatory measures that are taken, all of which are impossible to predict. Members acknowledged that the increased uncertainty could already be affecting the outlook, particularly for business investment, but it was not possible to assess the broader implications without more information.
Based on new data since October, members were generally more confident in the recovery in per capita spending and housing. But they agreed that the overall growth outlook was now softer than in October. Recent inflation was largely aligned with expectations, but if growth did not pick up, there could be more downside risk to the inflation outlook.
