A first glance at Statistics Canada’s second-quarter GDP report card suggests the economy earned a D minus. This is based on the fact that inflation -adjusted growth was a mere 0.3% quarter over quarter at annual rates. Moreover, this marginal second-quarter increase followed a weaker than previously reported 0.8% drop in the first quarter.

Looking at the details, GDP growth in the second quarter was primarily due to three expenditure categories which should continue to support the economy into 2009.

First, strong growth of disposable incomes continued to underpin consumer spending.

Second, although firms added to inventories in the second quarter, the ratio of inventory-to-sales in manufacturing is still relatively low.

Finally, while government spending growth will likely moderate following an unsustainable 4.5% second-quarter rise, it should remain strong given the healthy federal fiscal surplus.

Despite an easing of credit conditions and very strong growth of corporate profits, business spending on both non-residential construction projects and on machinery and equipment retreated (-1.4%) in the second quarter following a 2.1% increase in the first quarter. This was the first drop in investment since first quarter 2007.

In the latest quarter, declines in new construction and in renovation spending caused residential construction to decline by 3.9% following a 6.7% drop in the first quarter.

Looking ahead, a further weakening of housing demand will probably cause residential construction to slide further during the remainder of 2008 and into 2009.

However, given the steady improvement in corporate profits since the fourth quarter of 2007 and the fact that they picked up strongly in the second quarter, the prospects for investment in non-residential projects (particularly energy projects) appear to be better than previously anticipated.

Although the economy appears close to a technical recession (defined as two negative quarters), the fact that personal and corporate incomes grew at a healthy pace in the second quarter, that the unemployment rate is just slightly above its 25-year low and that a near record proportion of the working age population is employed, clearly suggest that GDP is not reflecting the whole story on the economy’s health.

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