In a surprising turn of events, the Canadian economy experienced more weakness in the second quarter than both the market and the Bank of Canada had anticipated. Real GDP dipped by a 0.2% annual rate during Q2, a significant departure from the expected 1.2% growth rate. This modest decline followed a downward revision of the 2.6% growth rate initially reported for Q1 (originally posted at 3.1%). The latest monthly data shows a 0.2% decrease in June, while the advance estimate for July's economic growth remained largely unchanged. These indicators suggest a sluggish start for the third quarter.

In July's Monetary Policy Report, the Bank of Canada had forecasted 1.5% growth for both Q2 and Q3. Given the recent economic performance, it seems justified for the central bank to hit the pause button on interest rate hikes when it convenes on September 6th. The report aligns with the recent uptick in unemployment rates and signals a reduction in excess demand, even after accounting for factors like wildfires and the BC port strike.

Key Highlights of Q2 Growth:

1.       Housing investment declined by 2.1% in Q2, marking the fifth consecutive quarterly decrease. This drop was primarily led by a sharp decline in new construction and renovation activities. It's no surprise, considering the increased borrowing costs and decreased demand for mortgage funds, following the BoC's raising of the overnight rate to 4.75% in Q2. Interestingly, despite higher mortgage rates, home resale activity saw an uptick in Q2, marking the first increase since Q4 2021.

2.       Notably, consumer spending growth decelerated significantly in Q2 and underwent a downward revision in Q1.

The Bottom Line:

The weakness revealed in today's data could signify the peak of interest rates on the horizon. While inflation remains a concern, the 5% policy rate should be sufficient to guide inflation back toward its 2% target over the next year. As annual mortgage renewals reach their zenith in 2026, the resulting increase in monthly payments is likely to further dampen economic activity and help curb inflation.

The Bank of Canada is expected to proceed cautiously in easing its monetary policy, with rate cuts likely beginning in the middle of the next year. In the interim, the central bank will persist in its commitment to combat disinflationary pressures with all available means.

Today's release of the US jobs report for August supports the belief that the Canadian overnight rate has peaked at 5%. While the headline number of job gains in the US exceeded expectations at 187,000, the unemployment rate rose to 3.8% as labor force participation increased, hourly wage growth remained modest, and job gains for June and July were revised downward.

In Canada, 5-year bond yields have dipped to 3.83%, well below their recent peak, as indicated in the chart below.

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