Canada / Spotlight Reports
Q4 2018 Canada Macroeconomic Update

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by Viraj D'Costa, Senior Technical Analyst; Mario Ismailanji, Lead Technical Analyst; Rachel Hyland, Lead Analyst; Anna Amir, Lead Analyst; Ryan Roth, Lead Analyst
Apr 02 2019

Canada’s inflation-adjusted GDP increased at an annualized rate of 0.4% in Q4 2018, bringing Canada’s real GDP down to 2.0% growth over 2018. This slowdown in growth is primarily a result of many sources of moderation, including interest rate hikes, Brexit and US-China trade tensions. The deceleration of GDP growth from Q3 to Q4 comes amid slowdowns in fixed capital investment and household consumption expenditure, as well as an increase in the consumer price index (CPI). Interest rates hiked in 2018 as inflationary pressures rose slightly amid increased consumer spending. This hindered consumer confidence and led to relatively high levels of economic uncertainty. Additionally, a struggling residential housing market and rising household debt in Canada is expected to remain a drag on the domestic economy, with volatile energy and commodity prices making matters worse in terms of trade in the fourth quarter.

Consumer Spending and Labour

The Canadian economy added a total 97,800 jobs in Q4 2018, including an increase of 78,400 in October alone. This represents a slight increase of 0.5% from the previous quarter. This job growth comes amid a decline in Canada’s unemployment rate, which fell from 5.8% in October to 5.6% at the end of December. The labour force participation rate did not change from the third quarter to the fourth, remaining at 65.4% in January. During Q4, the main sectors fuelling employment growth include educational services; information, culture and recreation; finance; real estate, rental and leasing; and wholesale and retail trade.

A falling unemployment rate and a relatively stable labour participation rate illustrates a relaxing labour market in Canada. In Q4 2018, average hourly earnings increased $0.23 to $27.21. This represents a year-over-year average hourly increase of $0.53, with large gains in Q4 alone. In 2018, household consumption expenditure in Canada has increased 1.3%, including a 0.2% increase in the fourth quarter. Most of this growth came from increased spending on services, which increased 0.9% in the fourth quarter and 0.5% over the year. Household consumption expenditure typically grows relatively moderately, which leads to expected Q4 growth.

Construction Trends

Fixed capital investment showed signs of decline in the fourth quarter, with gross fixed capital investment in nonresidential structures declining at an annualized rate of 15.0%. This decline is faster than that of the third quarter and is expected to be attributed to a slowdown in economic growth. Construction activity is typically seen as a leading economic indicator, emphasizing the potential negative effects of a slowdown in the fourth quarter. In Q4 2018, total nonresidential construction declined 4.0% to $11.3 billion. This decline in investment activity is relatively indicative of increased costs of borrowing associated with rising interest rates, as well as slowing economic growth. Construction spending often follows trends in consumer and business confidence, as businesses tend to spend more on projects they believe will increase revenue and remain profitable. In the fourth quarter, nonresidential construction activity declined across all three major nonresidential construction sectors, including industrial, commercial and institutional and governmental construction. While input costs for construction projects increased as a result of new steel and aluminum tariffs, nonresidential construction spending was also limited by rising wages. While consumer spending increased in Q4, a slowdown in economic growth deterred construction projects over 2018 and led to a decline in nonresidential construction activity.

Amid rising household debt and new mortgage regulations in 2018, residential construction declined over the year. This decline continued in the fourth quarter of 2018, despite a sharp rise in housing starts during the same quarter. Similar to the nonresidential construction sector, increased input prices contributed to a decline in residential construction in the fourth quarter. Additionally, interest rate hikes further contributed to a slumping residential construction market, placing further pressure on consumers looking to enter a new mortgage agreement. As the Canadian economy continues to adjust to changes in mortgage regulations and overall economic uncertainty, expectations for residential construction are estimated to remain relatively subdued.

Volatility in Financial Markets

During Q4 2018, financial markets experienced relatively high levels of volatility because of several sources of uncertainty. Trade tensions between the United States and China, Brexit and interest rate hikes highlight Canada’s main issues in Q4 2018, leading to high levels of investor uncertainty in financial markets. In October 2018, the Bank of Canada, which acts as the nation’s central banking authority and functions similarly to the Federal Reserve and the Bank of England, decided to increase its target rate to 1.75%, its highest level since 2008. This represents the third rate increase in 2018, as increasing inflationary pressures and slowdowns in economic growth have combined with geopolitical issues associated with Canada’s southern neighbour, the United States, to worry Canadian regulators. Additionally, the Bank of Canada has decreased its GDP forecast for 2018 to 2.0% growth in real GDP, which represents a decline from its previous forecast in a January Monetary Policy Report. Furthermore, a drop in commodity and energy prices during the period led to lower terms of trade for Canada in Q4 and contributed to slow domestic income growth. These factors have weighed on investor confidence and economic activity in Q4, leading to a significant decline in financial markets.

Overall, in Q4 2018, the S&P/TSX Composite Index, which represents the headline index and principal broad market measure for Canadian equities, fell 10.9%. For the year, the index finished 11.6% below where it began, illustrating the strain an uncertain Q4 had on Canadian equities. The index is heavily weighted with financials and energy, accounting for a respective 32.5% and 18.4% of companies in the index. Accordingly, significant changes in monetary financial systems and energy prices affect more than half the companies in the index at least on a broad level. With rising interest rates and a decline in commodity and energy prices, the worst-performing sectors of the index in 2018 were energy, consumer discretionary and financials. While political uncertainty surrounding pipeline prospects also weighed on energy stocks in 2018, a flattening yield curve and slowdown in Canadian housing significantly limited economic expansion fears, leading Canada’s biggest banks to experience losses in 2018.

Despite steep declines in Canadian financial markets at the end of 2018, the year posted a respectable finish in the IPO market following a record year in 2017. In 2018, the IPO market reached $2.2 billion in total for the year, boosted by heightened activity in the mining sector and expanding cannabis companies. The final quarter of 2018 saw 22 new equity issues between three different Canadian exchanges, increasing the total number of new equity issues in 2018 to 54. However, with 2019 appearing to be increasingly uncertain given trends in interest rates and global trade tensions, the IPO market is not expected to return to the same highs it reached in 2017. Similarly, merger and acquisition (M&A) activity in Canada increased in terms of actual deal value from 2017 but decreased slightly in the number of transactions. Amid relatively high volatility, materials and energy and power sectors account for more than half of Canadian M&A activity. Although 2019 will be less optimistic with a potential slowdown in economic growth, M&A activity is expected to be benefited by tech disruption and new cannabis legalization.


Edited by Becky Simon