Articles
28 August 2018

Canada: Expect strong growth as tariff bruises are yet to show

A strong 3% Canadian growth figure on Thursday would indicate the actual impact of the global trade war so far has been fairly modest. But despite hints of Nafta progress, trade tensions are likely to remain a major uncertainty in the second half of 2018

So far at least, there are few signs that the uncertainty surrounding US trade policy is translating into slower Canadian growth. That’s the story we’re likely to get from Canada’s 2Q GDP release on Thursday, where we expect a firm 3% annualised growth figure.

3%

ING 2Q GDP Forecast

QoQ% Annualised

Investment and exports, particularly in the manufacturing sector, are likely to be key drivers as firms continue to benefit from strong overseas demand. This may be somewhat dampened by household spending, which took a hit from cold weather back in April, and is likely to be increasingly restrained by the combination higher interest rates and tighter mortgage rules. Although 2Q growth in spending is still expected to be seen, albeit more moderated.

Household spending relationship from 1Q to 2Q

Source: Macrobond
Macrobond

A widening trading relationship between the US and Canada would make a trilateral NAFTA appear off the cards

So what next? Well, as the headlines over the past couple of days have shown, there’s still a clear threat that tensions with the US on trade could escalate further. Following his agreement with Mexico, President Trump is putting pressure on Canada to get on board quickly and accept a deal or risk facing tariffs on all auto exports to the US.

While there are many Congressional hurdles that the President would need to overcome in order to change or replace Nafta (see our trade team’s piece for more), the uncertainty could prove to be a serious headwind for growth, particularly if confidence starts to take a more noticeable hit. A further escalation in tensions risks hitting supply chains with Canada’s most important export partner, while any subsequent retaliation could put up prices for Canadian consumers.

Implications for growth and the Bank of Canada

Having said all of that, as long as actual trade terms remain unchanged, the economy should continue to reap the rewards of strong US activity. On the back of recent fiscal stimulus US growth set to remain buoyant for at least a couple more quarters, so the decent momentum in Canadian data could persist for a little while longer.

For that reason, we continue to expect a further rate hike from the Bank of Canada in the second half of the year. Indeed a surprise at the September meeting shouldn’t be completely ruled out, given the Bank’s history of catching markets off guard. Investors are currently pricing just a 22% chance of September rate rise.

But as we head into 2019, things look a little more uncertain. US growth may begin to ease off to some degree as the tax cut tailwind fades and trade uncertainty hits, while higher borrowing costs in Canada could begin to bite. That means Thursday’s growth reading could represent something of a short-term peak, particularly given that trade uncertainty is unlikely to dissipate fully ahead of the November US mid-term elections.

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