The Weekly Wrap for July 14, 2023
Higher interest rates, lower inflation in the US, and Stampede spending
By Mark Parsons, ATB Economics 14 July 2023 8 min read
In this week’s ATB Economics Weekly Wrap…
- Bank of Canada serves up another rate increase and a “soft landing” forecast
- US inflation hits two-year low
- Residential construction in Alberta: Pull now, push later
- A repeat of 2016? Oil production resilient amid May wildfires
- Chart of the week: Recreation spending during Stampede
Are we there yet? Policy interest rate highest since spring 2001 - In a widely expected move, the Bank of Canada raised its policy rate for the second straight month. Not only that, there was a noticeable “inflation fighting” (or hawkish) tone as the Bank reiterated its "resolute” commitment to its inflation target.
In a span of just 17 months, the rate has increased 4.75 percentage points to 5%—one of the most dramatic tightening cycles since the early 1990s.
The Bank has preached data dependency, and the latest data just weren’t “slow” enough for it to sit on the sidelines. Even with two straight upticks in the national unemployment rate and some moderation in wage growth, the Bank emphasized that the labour market remains tight, consumer spending strong, and core inflation sticky.
Recall that in January the Bank signaled a conditional pause, and markets were anticipating that rates would hold and then decline. Since then, inflationary pressures simply haven’t cooled as much as the Bank would like, turning a five-month pause into two straight monthly hikes. For more financial commentary, see this article prepared by ATB Financial Markets.
The Bank’s updated forecasts, also released Wednesday, revealed three main things.
- Surprisingly resilient consumers - The economy has far outperformed the Bank’s expectations, and that can mostly be chalked up to consumer spending. Growth in the first two quarters was revised up a collective 1.3 percentage points since April. Population growth, household savings, and a tight labour market were all cited as reasons why consumers continued to spend.
- 12-month cool down - The long expected slowdown is coming. The Bank now expects GDP growth to ease to about 1% over the next 12 months before a rebound in the second half of next year. Not great, but not terrible either. This is a “soft landing” if all goes as planned.
- 2% inflation will need to wait - The Bank pushed out its return to target inflation by two quarters to mid-2025.
What’s the Bank’s next move? The Bank provided almost no clues, and the forward-looking language was mostly unchanged from the June statement. At the press conference, Governor Macklem indicated that the Governing Council discussed the possibility of “holding rates unchanged and gathering more information,” which could be interpreted that we’re close if not already there. But overall the press conference reiterated the Bank’s data dependent stance. As for financial markets, they are expecting that the policy rate will hold fairly steady for the rest of the year (5.1% forecast for December on July 13). The next rate decision is September 6.
What about Alberta? The Monetary Policy Report paints a national picture, and rarely gets into individual provinces. That said, the Bank highlighted that the anticipated drop in exports and investment growth is a non-resource story; investment intentions among resource linked firms remain strong and commodity exports are expected to increase. The Trans Mountain Expansion project is referenced as a “supply improvement” for 2024.
Bottom line(s): This is a challenging time for many borrowers across Canada, including in Alberta. We expect higher rates will weigh on consumer spending in the province, especially on discretionary items, in the second half of the year. The impact is lagged, as most Canadians have yet to renew their fixed mortgages at higher rates.
The silver lining is that, assuming inflation falls in line with Bank expectations, we appear to be near the end of this difficult tightening journey.
The relative strength in the resource sector cited by the Bank, along with sizable interprovincial inflows, reinforces our view that Alberta’s economy is expected to outperform this year and next.
Inflation cools in the US - Just minutes before the Bank announcement on Wednesday, the US reported some positive inflation news. The Consumer Price Index rose 3% year-over-year (y/y) in June, the lowest reading in two years. As in Canada, this is primarily an energy price story—the core reading (ex. food and energy) improved as well, but remained elevated at 4.8% y/y. The Federal Reserve was widely expected to raise its overnight rate later this month, and this report does not fundamentally change that view.
Residential construction: Pulling now, pushing later - Headline numbers rarely give the entire story. Such is the case for Alberta building permits, which are a leading indicator of construction activity. Overall permits were up in May, but are still down from last year’s levels on a year-to-date basis.
Looking closer, the entire decline so far this year is residential. Part of this is base year effects: May 2022 residential permits spiked to their highest level since 2016. But it’s also a function of rising interest rates and the associated drop in housing demand. A shortage of construction workers is also weighing on the sector (vacancies in construction were 12,060 in the first quarter, second only to food and accommodation services). Meanwhile, non-residential permits are essentially flat compared to last year—institutional declines have offset industrial and commercial gains.
Can the weakness in Alberta’s residential construction sector last? Probably not, even if the latest interest rate increase delays the recovery. Population growth is running at a four-decade high, driving up rates of household formation far beyond the current pace of construction. The housing market is tightening, with the inventory of homes falling to 2.7 months of supply in June (the 10-year average is 5.4 months of supply). Residential sales bottomed out in February, but have risen for four straight months since then.
The rebound is showing up in prices as well. Alberta housing prices (measured by the MLS composite price index) edged up in the spring and in June surpassed their previous peak reached in April 2022, with especially large gains in Calgary. Albertans seem convinced that the market will improve further, though expectations for housing price increases over the next 12 months are moderate: 4.1% compared to 4.3% nationally.
Bottom line: Residential activity was one of the first victims of higher interest rates. The latest rate increase may cause some prospective buyers to sit on the sidelines. However, we see the pullback as temporary given the heavy demand-pull from migration, and are forecasting a rebound in residential construction in 2024. The first hint was a spike in Alberta housing starts in May, but it’s too early to tell if this is the beginning of a new trend.
Oil production resilient amid wildfires - In May, our view was that the wildfires would disrupt oil production, but not nearly to the same extent as in 2016. This call came with a major caveat: that the oil sands region (with over 80% of production) remains unscathed, and that the wildfires would come under control.
We now have May data on crude oil production that confirm this. There was a decline in May of 1% year over year (y/y), but much smaller than the 18.5% y/y drop experienced in May 2016.
The impacts are different in another way. The production shut in last May was conventional oil and gas, and natural gas liquids. In 2016, it was primarily bitumen.
Bottom line: Overall oil production dipped in May, but nothing like that experienced in 2016. In our June outlook, we estimated that oil and gas production disruptions from the wildfires would shave 0.1% off Alberta’s real GDP this year.
Chart of the week - Recreation spending during Stampede
As the Stampede wraps up this weekend, our Chart of the week is once again focused on the big event. Last week, we looked at airport visits from international guests during the Stampede. This week, we dive into spending patterns.
Anyone attending the event will notice booked hotel rooms and busy restaurants and bars. Attendance is strong and on pace to set a new record. Can we see an uptick in recreation spending during Stampede? Unfortunately, the standard data on retail sales and restaurants and bars are not much help. They are monthly, and the Stampede is a 10-day event.
We’re interested in Alberta lodging and entertainment related spending during the Stampede in Alberta. We take advantage of higher-frequency daily data from ATB consumer Mastercards on dining, entertainment, hotels and lodging. We then look at levels before, during, and after the Stampede.
Smoothing the data, and creating an index, the chart shows a noticeable uptick during the Stampede in 2022, which was held July 8-17.* We compare this change to the same period in 2020, a year the Stampede was canceled due to the pandemic. That year, spending levels on recreation and entertainment were depressed and remained relatively flat through late June and July.
A caveat: this only covers spending using ATB consumer Mastercard transactions, and may not be fully representative of the spending patterns in the province.
*The construction of the index using a 7-day moving average means that Stampede period impacts persist (at a declining rate) for several days after July 17 in 2022.
Interesting fact… The percentage of Albertans who speak a language other than French or English at home has doubled since 1981 - According to new tables drawn from census data, 15% of Albertans in 2021 said the language they speak most often at home is not one of Canada’s two official languages, up from 7.2% in 1981 and 14.2% in 2016. The national average is almost the same at 14.5%, but there are large differences across the provinces. Among the provinces, BC has the largest percentage at 19.1% followed by Ontario at 18.1% with Alberta in third spot just ahead of Manitoba at 14.9%. If the territories are included, Nunavut has the largest percentage of people who speak a language other than French or English at home, but it has fallen from 57.7% in 2001 to 47.3% in 2021. In the middle of the provincial pack is Quebec at 9.1% with the Atlantic provinces ranging from a high of 6.5% in P.E.I. to just 1.7% in Newfoundland and Labrador.
Answer to the previous trivia question: The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) is a free trade agreement between Canada and ten other countries (Australia, Brunei, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam).
Today’s trivia question: According to Trade Data Online, what was the combined dollar value of Alberta’s exports to Japan, China, and South Korea last year?