Fundamental Analysis, 11 Sept 07

Daily Economic Update

Canadian housing starts beat expectations

Housing starts were stronger than expected in August, coming in at a 226,500 annualized rate, firmer than market forecasts for 220,000 units and faster than July's 215,600 unit rate.

Multiple-unit starts rebounded, rising 10.1%, more than reversing July's 8.4% dip. Urban single-unit starts edged up by 1.8% following a 2.7% drop in July. Increases were posted in four of five regions, with only Quebec posting a decline in the month.

Although off the recent high of 253,300 recorded in January, housing starts are still rising at a decent pace. On average, the rate in the first two months of the third quarter was a firm 221,000, only slightly slower than the second quarter's 226,400 average, indicating that Canada's housing market continues to perform well, backed by strong employment gains and income growth.

Our forecast is for starts to continue at a 200,000-plus annualized rate for the remainder of 2007, slower than in the first six months of the year, but still strong by historical standards.

Canada's trade surplus was much smaller than expected in July

Canada's merchandise trade surplus was smaller than expected in July at $3.7 billion, with forecasters looking for a $5 billion surplus and June's surplus was revised down by $1 billion to C$4.3 billion. Exports increased by 1.4%, while imports rose by a sturdy 3.5%.

Exports of industrial goods, automotive products and machinery and equipment increased in July, more than offsetting a sharp drop in sales of energy products and lower forestry and agriculture goods sales.

Imports reached a new record high in July on the back of rising purchases of automotive products, machinery and equipment and consumer goods. Imports of energy products fell by 10.6%, which moderated the monthly increase in overall import growth.

In constant 2002 dollars, exports increased by 2.9% in July, while imports increased at a stronger 5% pace, continuing the trend of import growth outperformance evident in the second quarter and pointing to the sector acting as a weight on the pace of economic activity in the third quarter.

The steady performance of the Canadian dollar against the U.S. dollar in August combined with robust domestic demand set up for import growth to remain strong throughout the third quarter, with export growth likely to increase at a slower pace in line with the weakening in the U.S. economic activity.

This combination will likely see the trade sector remain a drag on the overall pace of economic growth, although continued strong consumer and business spending will keep the economy on its current strong growth path.

Economic data will continue to take a backseat to developments in financial markets. Even though the strong domestic economy and persistent upward pressure on housing prices would normally see the Bank of Canada tighten monetary policy, we expect that the volatility in financial markets and increased downside risks to the U.S. economic outlook will keep the Bank on the sidelines for now.

Canada's new housing price index continues slowing trend

The new housing price index increased 0.9% in July and was up 7.7% on a year-over-year basis, down from the 12.1% peak reached last August, and marking the 11th straight month of slower annual increases.

Despite the slowing trend, the rate of increase in the house-only portion of the index, which feeds into the CPI, came in at a firm 0.7%, pointing to persistent upward pressure in this component of the consumer price index.

Modest improvement in U.S. trade deficit

The U.S. international trade deficit improved modestly in July to US$59.2 billion from an upwardly revised US$59.4 billion in June (previously reported at US$58.1 billion). Going into the July release, the deficit had been expected to deteriorate to US$58.8 billion from the initially reported June level.

The modest improvement resulted as exports rose a stronger-than-expected 2.7%, building on the 1.3% gain in June. This more than offset the 1.8% increase in imports in the month.

The expected deterioration in the July trade balance was based on earlier indications of rising oil prices boosting nominal imports. This was confirmed with today's report as average oil prices in July rose to US$65.56/bbl from US$60.95/bbl in June. The rise in overall imports also reflected a increase in the auto and parts component. However, these gains were more than offset by widespread increases in exports including gains in capital goods, autos and parts and civilian aircraft.

The improvement in July reflected a solid increase in exports, reflecting strong global demand and the earlier depreciation of the greenback that more than offset a sizeable rise in imports.

These numbers are generally consistent with our expectation that trade will continue to be an add to growth in the third quarter, although likely only contributing about one-third of the 1.4 percentage-point contribution made in the second quarter. Strength in trade is expected to be an important offset going forward to weakness in the domestic economy resulting from the recent financial market turmoil.

RBC Financial Group

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