Both goods and services sector output contracted in August with the goods sector slumping by 0.6% on the back of lower output from the mining and oil and gas industries as well as softer manufacturing and construction activity. The decline in output in the energy sector followed an outsized 2.7% increase in July. In the services sector, wholesale trade recorded a 3.1% drop (following a 1.9% surge in July), with transportation and warehousing and health care also posting notable declines. Retail activity was flat in the month and finance, insurance and real estate recorded marginal 0.1% growth.

The decline in GDP in August dented July's strong gain and makes it likely that the economy expanded at a 1.5% annual rate in the third quarter, somewhat slower than our earlier forecast for a 2.5% increase. Even at this slower pace, we still think it is likely that the third quarter will mark the high-water mark for growth this year with financial market stress through the autumn keeping the cost of capital high and the U.S. economy likely having slipped into recession.

In their Monetary Policy Report, the Bank of Canada cut their forecast for GDP growth in the second half of 2008 and first half of next year. By our reckoning today's data provide some upside risk to the Bank's call that the economy expanded a meagre 0.8% annualized pace in the third quarter, although we agree with its forecast for a mild contraction in the fourth quarter. On balance, today's data support the Bank's statement that "some further monetary policy stimulus will likely be required" to keep inflation on target and we look for another 25 basis-point cut in the policy rate to 2% before year-end.

U.S. personal consumer spending takes a hit
Personal consumer expenditure (PCE) fell 0.3% in September following unchanged spending in August. Market expectations had been for spending to fall 0.2% in the month. The decline occurred despite a 0.2% rise in personal income.

The decline in consumer spending was led by the durables component, which dropped 3.1% as auto sales fell to an annualized 12.5 million units. Weakness was also evident in the non-durables component, although the decline was a more moderate 0.6%. The services component managed to rise 0.3%. On a constant dollar basis, the pattern of spending was very similar. Overall consumer spending fell 0.4% after no change in August. The drop was led by durables (-2.9%) and to a lesser extent non-durables (-0.8%) with the services component up marginally (+0.2%).

The core PCE deflator rose 0.2%, slightly greater than the 0.1% expected going into the report. However, the increase did not prevent the year-over-year rate dropping slightly to 2.4% from 2.5% in August.

The decline in constant dollar consumer spending in September was already reflected in yesterday's third-quarter advance GDP report showing that consumer spending plunged an annualized 3.1%. Some of the weakness in the quarter may have reflected personal spending returning to its previous trend level after being temporarily boosted by the tax rebate cheques issued in the second quarter.

However, with suggestions that employment declines are possibly intensifying and that spending momentum faltered late in the third quarter, the risks are that consumer spending will likely continue to decline in the final quarter of the year. The Fed's 50 basis-point reduction in the Fed funds rate earlier this week to a highly stimulative 1.00% was in part meant to address these downward pressures to growth. We expect these stimulative conditions to be maintained through next year to help sustain a return to positive growth over the course of 2009.