Canadian Manufacturing Output in 2006 May Lag GDP Growth

Solid Canadian gross domestic product (GDP) growth in the second and third quarters of 2005 will give way to a slight deceleration through 2006, according to a new report.

In "Review of the Canadian Economy, 2005-2006," Jeremy A. Leonard, Manufacturers Alliance/MAPI economic consultant, writes that "the economic outlook for Canada is positive, notwithstanding the many downside risks in the global economy."

Real GDP growth grew 3.6 percent in third quarter 2005 and a revised 3.4 percent in second quarter 2005. The consensus forecast is for more modest growth of just under 3 percent through the end of 2006.

Manufacturing has been virtually stagnant for the past year. Manufacturers, who account for three-quarters of merchandise exports to the U.S., were especially buffeted by the strong appreciation of the Canadian dollar. It currently trades above 85 U.S. cents, with expectations that it will remain at that level or even rise to the 90 cent range in 2006 if high crude oil and commodity prices persist.

Manufacturing declined by 1.7 percent at an annual rate in the second quarter of 2005 (the worst quarterly performance in two years) and grew only 0.3 percent in the third quarter. Weakness was prevalent in transportation equipment, in particular exports of motor vehicles and parts to the U.S. Aircraft equipment demand eased as well, and softness was seen in wood and paper products, lumber production, and, due to high crude oil prices, petroleum and coal products and chemicals. However, production of computers and electronic equipment has increased at double-digit rates year-over-year for the past 24 months.

Leonard explains that since Canada is a net exporter of energy, high crude oil and natural gas prices will actually have a positive economic effect in the medium term, particularly with regard to demand for capital investment in oil exploration, extraction, and refining. Energy-intensive manufacturers, though, will face headwinds.

The main risk to Canada's economic outlook continues to be the potential impact of high energy prices on the U.S. and global economies. A protracted slowdown in the U.S. would substantially reduce export growth, and an abrupt global slowdown, especially in China, could end the current strength of commodity prices on which Canada's economic health depends.

The unemployment rate stands at 6.4 percent, the lowest in more than 10 years, but job growth was concentrated entirely in the services sector over the past year. Manufacturers shed 100,000 jobs during that period, as the appreciating dollar forced Canadian exporters to cut costs and lay off personnel.

"Buoyant domestic demand by new job creation has allowed the Canadian economy to weather the effects of the strong dollar on exports," Leonard said. "But the large numbers of exporters will not be competitive at an 85-cent dollar without changing their cost structure, so job and output weakness in manufacturing are likely to persist."