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The Globe and Mail

This leading indicator predicts the economy will soften

Canadian gross domestic product for the third quarter was reported well above economist expectations Friday but an index of leading economic indicators suggests the party may be short-lived.

Domestic economic growth came in 0.2 per cent ahead of estimates at 2.7 per cent, but that's the past. The MacDonald Laurier Institute Leading Indicator (MLI), developed by former StatsCan economist Philip Cross, uses a series of economically-sensitive measures to predict future activity. The chart below shows the index's considerable success at predicting economic growth rates.

The MLI report was also released Friday, and told a much less optimistic story than GDP. Declines in commodity prices and the average work week slowed the MLI benchmark from a 0.3 per cent gain in September to a 0.1 per cent pace for October.

Macdonald-Laurier Institute leading indicator vs Canadian GDP

Both figures year over year % change

SOURCE: Scott Barlow/Bloomberg/Macdonald-Laurier Institute

Mr. Cross uses the interest rate gap, another component of the index, to gauge the riskiness of corporate loans. The interest rate gap figure measures the difference between government bond rates and corporate lending rates, and right now, it's worrying. The 0.2 month over month fall indicates that lenders are more skeptical about future corporate profitability.

The weakness apparent in the most recent index reading is temporary, Mr. Cross believes. He notes that the five month moving average of the MLI remains well into positive territory. Nonetheless, investors should temper any optimism from this morning's GDP report – a soft patch is looming for the domestic economy.

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