ECONOMIC VIEWPOINT

François Dupuis, Vice-President and Chief Economist • Mathieu D’Anjou, Deputy Chief Economist • Benoit P. Durocher, Senior Economist

Desjardins, Economic Studies: 514-281-2336 or 1 866-866-7000, ext. 5552336 • desjardins.economics@desjardins.com • desjardins.com/economics

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Canada’s economic growth in the last few years has largely relied on robust household spending. In recent quarters, however, household spending has hit a few snags. On one hand, residential investment is declining while the combined effects of tighter mortgage measures (including the Office of the Superintendent of Financial Institutions’ [OSFI] Guideline B-20) and gradually climbing interest rates are being felt. Considering the frenzy in Canada’s real estate sector in the last few years, this type of slowdown is good for the long-term health of Canada’s economy. On the other, household consumption spending has been advancing at a much slower pace since the end of 2017 (graph 1). This raises some concerns about

the contributions consumer spending will make to Canada’s economic growth in the quarters ahead.

Rate Hikes Being FeltWeak consumer spending is also reflected in the value of retail sales, which has fallen slightly since mid-2018 (graph 2). The sharp decline in gas prices—from an average of ¢140.1 per litre for regular gas across Canada during the week of May 22nd, 2018, to only ¢105.3 per litre the week of February 5, 2019—has greatly contributed to reducing the value of service station sales in recent months. That said, some other sectors also had difficulties (graph 3 on page 2), i.e.,

Is Higher Consumer Spending Growth in Canada Still within Reach?

ECONOMIC STUDIES | MARCH 7, 2019

GRAPH 1Consumer spending is growing more slowly

Sources: Statistics Canada and Desjardins, Economic Studies

Household consumption spending in real terms

In 2012 $M

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1,050,000

1,070,000

1,090,000

1,110,000

1,130,000

1,150,000

1,170,000

1,190,000

2015 2016 2017 2018

Level (left)Annual variation (right)

In %

GRAPH 2The value of retail sales has been flat for several months

Value of retail sales

In $B

40

42

44

46

48

50

52

2015 2016 2017 2018

Mill

ions

Sources: Statistics Canada and Desjardins, Economic Studies

Canadian household consumption spending has slowed significantly in the last few months. This is partly explained by the decline in furniture sales, dragged down by the housing market’s pullback, and slower growth in automobile sales after several years of strong growth. Gradually climbing interest rates are another important factor, while the savings rate is very low from a historical standpoint, which reduces the financial flexibility in households. Thankfully, some bright spots remain. Moreover, strong job creation is giving a boost to households’ disposable income. Under these conditions, consumer spending should continue to grow in the next few quarters, but at a moderate pace.

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2MARCH 7, 2019 | ECONOMIC VIEWPOINT

motor vehicles and furniture. These two sectors have something in common—both are particularly sensitive to interest rate fluctuations. Climbing interest rates, which have been ticking up since mid-2017, have clearly put the brakes on sales growth in these sectors. In fact, consumer credit growth has slowed sharply in the last few months (graph 4).

However, other sectors that are also sensitive to interest rate fluctuations are doing better, such as electronics and appliance stores. Besides interest rate hikes, other factors seem to be at play here. The current slowdown in the housing market is undeniably taking a bite out of furniture sales. With regard to motor vehicles, the last few years have been exceptional for this sector, with sales growth outpacing the average for overall retail sales by far (graph 5). The recent weakness in motor vehicle sales can therefore be seen as a temporary consolidation within the sector after several years of sharp growth. In addition, the automobile industry is undergoing several technological changes at the moment, pushing some buyers to put off their purchases and wait for new technological features that will soon be available.

Less Wiggle RoomThat said, some of the underlying fundamentals that influence changes in consumer spending have also been less favourable in the last few quarters. Household net saving—the difference between a household’s income and expenses—is lower (graph 6). This has greatly contributed to reducing the household savings rate, which stayed at a particularly low level in the fourth quarter of 2018, historically speaking (graph 7). The financial

GRAPH 3Some retail sectors are lagging

Sources: Statistics Canada and Desjardins, Economic Studies

Value of retail sales

Jan. 2017 = 100

91

94

97

100

103

106

109

112

JAN. APR. JUL. OCT. JAN. APR. JUL. OCT. JAN.

Motor vehicles and furniture Service stations Other

2017 2018 2019

GRAPH 4Consumer credit growth is slowing

Sources: Statistics Canada and Desjardins, Economic Studies

Consumer credit outstanding

In %

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

0

1

2

3

4

5

6

2012 2013 2014 2015 2016 2017 2018 2019

Annual variation (left)

3-month variation (right)

In %

GRAPH 5Automotive product sales growth has stood out in recent years

Sources: Statistics Canada and Desjardins, Economic Studies

Value of retail sales

Annual variation in %

0

2

4

6

8

10

12

2010 2011 2012 2013 2014 2015 2016 2017 2018

Motor vehicles and parts Other sectors Total

GRAPH 6Household savings have declined in recent quarters

* Including changes in pension rights.Sources: Statistics Canada and Desjardins, Economic Studies

Household sector

350

550

750

950

1,150

1,350

0

10

20

30

40

50

60

70

80

1990 1995 2000 2005 2010 2015

Mill

iers

Mill

iers

Net savings (left)Disposable income* (right)Final consumption spending (right)

In $B In $B

GRAPH 7The household savings rate is very low, historically speaking

Sources: Statistics Canada and Desjardins, Economic Studies

Household savings rate

In % of disposable income

0

5

10

15

20

25

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

3MARCH 7, 2019 | ECONOMIC VIEWPOINT

ECONOMIC STUDIES

leeway in households seems to be fairly weak. This conclusion is obviously closely linked to the high debt levels in households, while the interest paid on their loans erodes a growing share of their income (graph 8). In such conditions, households are far more sensitive to interest rate hikes than in the past.

There is, however, every reason to believe that there is still room for consumer spending to keep rising in the coming quarters. The employment market remains strong, and job creation is still very solid (graph 9). Even though wage growth is still moderate, the rise in the number of workers should help lift the disposable income for all households. Assuming that previous increases in the target for the overnight rate will continue to be gradually incorporated into the average effective interest rate for household borrowing and that outstanding credit will continue to increase, albeit at a slightly slower pace, we can make predictions on changes in consumer spending using different scenarios for the savings rate.

Based on our assumptions, maintaining a savings rate at the current level (1.1%) would be consistent with average consumer spending growth of about 1.5% (annualized) in the coming quarters. This is almost consistent with the increase recorded since the beginning of 2018, or the status quo.

On the other hand, if we assume that households are dipping into their financial margins by pushing their savings rate to almost zero, this would help consumer spending grow at a rate of about 2%. But even if this more extreme scenario were to take place, consumer spending growth would still have a tough time reaching the same heights seen in recent few years.

In contrast, it goes without saying that if households increase their savings rate in the next few quarters, this will significantly curtail consumer spending growth. For example, a savings rate of about 2% at the end of 2019 would be consistent with virtually zero growth in consumer spending in the next few quarters.

The main observation in all three scenarios is crystal clear. Consumer spending growth will remain relatively modest in the quarters ahead.

Consumer Spending Growth Set to ModerateOur baseline scenario uses a relatively stable savings rate for the next few quarters, which assumes that consumer spending will grow in line with disposable income. Under these conditions, consumer spending could maintain a growth rate between 1% and 2% in the next few quarters. Since household consumption spending accounts for nearly 60% of Canada’s total real GDP, this will have a significant impact on Canada’s economic growth, which should remain below 2% on average until the end of 2019.

That said, given households’ weak financial leeway, the risks associated with lower-than-expected consumer spending growth are high. The next few months will be decisive on this score. The Bank of Canada will have to be patient and not raise its key interest rates for an extended period. This long pause will help it better understand and note the real impact of higher interest rates on consumer spending. Should the restrictive effect of the previous rate hikes turn out to be greater than expected, the current pause could become the end of the monetary tightening cycle.

Benoit P. Durocher, Senior Economist

GRAPH 8Interest payments eating up a larger share of household income

Sources: Statistics Canada and Desjardins, Economic Studies

Household sector

In $B

-200

0

200

400

600

800

1,000

1,200

1,400

1990 1994 1998 2002 2006 2010 2014 2018

Interest paidDisposable income before interest paymentsDisposable income

GRAPH 9The labour market remains very strong

Sources: Statistics Canada and Desjardins, Economic Studies

Annual variation in %

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

-3-2-1012345

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Employment (left) Unemployment rate (right)

In %