Canada merchandise trade surplus slipped in July to C$4.9 billion from June's revised surplus of C$5.6 billion (originally reported as C$5.8 billion). July's surplus was much smaller than market forecasts for a C$5.6 billion overrun. Exports rose by 2.2%, while imports rose by a stronger 4.6% in the month.

The rise in exports largely reflected higher sales of industrial goods (up 5%) and machinery and equipment (up 6.6%). Exports of energy products dipped in July as falling volumes outpaced the rise in prices. This marked the first month in nine that energy exports declined. The rise in imports was broadly based, with auto imports posting a sold 9.5% gain on the back of strong Canadian auto sales early in first half of the year. Industrial materials and machinery and equipment imports also posted healthy increases.

On a volumes basis, exports increased by 1.7%, while imports jumped 3.6%. As a result, the net export balance in volume terms deteriorated, with the July deficit rising to C$7.1 billion (in 2002 constant dollars) from $6.2 billion in June.

After trimming 2.8 percentage points from the second quarter's annualized economic growth rate, the deterioration in net exports on a volumes basis in July sets up for this sector to be drag on the economy's growth rate again in the third quarter. However, we still expect the economy to accelerate after the very tepid growth recorded in first six months of 2008 based on our view that consumer spending will pick up pace, that business investment will rebound after a soft second quarter and that there will be another quarterly inventory build, backed by the continued support from the terms of trade boost.

These factors will likely prove sufficient to offset the drag from net exports and boost the economy. Recent reports support this view, with employment retracing some of July's decline and housing starts rallying strongly in August, even though the gain was narrowly based in multi-unit starts in Ontario. The data to date for the third quarter are unlikely to see the Bank of Canada have a change in heart about the balance of risks to the inflation outlook in the medium-term, pointing to policymakers holding the overnight rate unchanged at 3.00% through the end of this year.

U.S. trade balance deteriorates in July
The U.S. international trade deficit posted a sizable increase in July, beating expectations for a more mild deterioration. The trade deficit widened to US$62.2 billion from US$58.8 billion (revised up from US$56.8). Exports increased by 3.3%, while imports rose 3.9%.

Exports of industrial goods, automotive vehicles and parts and consumer goods rose in July. Imports of petroleum products rose 13.7% in the month as the price of crude rose to US$124.7 per barrel from the prior month's US$117.1 per barrel and the volume of imported barrels rose to its highest level in four years. July's increase in imports was also supported by higher purchases of industrial supplies and capital goods.

After providing solid support for the U.S. economy during the past five quarters, the trade sector started the third quarter on a weaker note as import growth outpaced exports, mainly due to the high price of imported oil. Notably, the non-petroleum trade deficit was its narrowest since October 2002. The lagged impact of the steady weakening in the U.S. dollar in the past year will likely support continued export growth, albeit at a slower pace than Q2's whopping 13.2% annualized rate, while import demand is likely to weaken. In August, import prices fell by 3.7% on the back of a sharp drop in the cost of imported oil, which fell 12.8% from July. This marked the first decline in import prices since last December.

RBC's U.S. consumer confidence index rebounds for second month
RBC's CASH index rebounded for the second month running in September after falling to an all-time low in July. The improvement was broad-based with the most notable gain in the expectations component, which surged to 76.3 from -4.7 in August. The drop in gasoline prices in recent weeks likely supported the confidence improvement supplemented by the highly publicized support for the U.S. housing market giants Freddie Mac and Fannie Mae. Interestingly, the component measuring consumers' confidence in making new investments rose 20 points to 63.8, with 44% of those surveyed indicating that it is a good time to buy real estate and one-third saying that it is a good time to buy equities.

On the jobs front, 46% said that they believe it is unlikely that someone they know will lose their job during the next six months, the highest percentage since April, with 23% expecting job losses in the months ahead. On balance, the report showed less pessimism on the jobs outlook despite the fact that U.S. payrolls declined by 84,000 in August, marking the eighth consecutive month of job losses, and the unemployment rate spiked to 6.1% in August from 5.7% in July.

This report provides a ray of hope that the U.S. consumer will continue to be active even as the support from the tax rebate cheques wane and the housing market correction continues. While the fall in gasoline prices in recent weeks comes as a welcome relief, the persistent softening in labour market conditions, the soggy housing market and tight credit conditions will continue to be powerful factors dampening activity in the months ahead. Despite today's heartening report, we remain cautious about the outlook for consumer spending in the second half of year and anticipate some payback after the tax rebate-supported boost to spending in the second quarter.