The July manufacturing sales report indicated that all of the weakness in June was more than reversed with sales jumping 2.7% in the month following the 1.3% decline in June (originally reported as -1.5%). Expectations were for a bounce back in manufacturing activity although by a more moderate 1.4%. Statistics Canada commented that about three-quarters of the strength was concentrated in Ontario. The story on a volumes basis was equally impressive with activity in July up a robust 2.8% following a 1.5% drop in June.

Expectations of an increase in July were largely based on indications of the ending of production shutdowns in the petroleum and coal sector along with an easing of the supply-chain problems in the auto sector. Both of these factors were confirmed in today’s report. Petroleum and coal were up 6.1% following a 6.0% drop in June. With respect to motor vehicle production, it rose 5.5% following steady declines in the second quarter of 2011 of 9.4%, 2.0%, and 1.8% for April to June, respectively. The report also showed a huge 7.6% jump in primary metal component. In part, this reportedly reflected the cessation of maintenance shutdowns that sent output in June down 2.4%; however, the strength likely eflected continued demand globally for various natural resources. Strength in the month was also evident in an 8.7% surge in the fabricated metal component.

A key offset to this strength was a 17.5% plummet in the aerospace sales. After a strong first quarter of the year, sales in this sector have generally been declining.

In terms of other components in the manufacturing report, inventories declined for the first time since September of 2010 albeit by a modest 0.1% that largely reflected weakness in petroleum and coal. In the face of the jump in sales, this pushed the inventory-to-sales ratio down sharply to 1.35 in July from 1.39 in June. Unfilled orders rose a strong 2.2% led by a 7.6% gain in the machinery industry, a 4.1% gain in the fabricated metal sector, and encouragingly, a 1.8% gain in the aerospace component.

The solid increase in the volume of manufacturing sales in July that more than reversed the decline in June provides support to the view that a component of the second-quarter 2011 weakness was transitory and that activity will rebound in the third quarter. Indeed the report confirmed a pick up in petroleum and coal production after maintenance shutdowns lowered activity in the previous month. As well, the first gain in motor vehicle sales in four months suggest that supply-chain disruptions related to the natural disasters in Japan are starting to reverse. Today’s report is consistent with manufacturing output contributing to growth in monthly GDP for July after the 0.2% gain in June. Our expectation of a monthly increase in that month of around 0.5% is also premised on the 5% plummet in mining output in May continuing to be more fully offset after June's marginal 0.7% rise. This weakness largely reflected forest fires around the Alberta oil sands that curtailed production late May and early June.

A strong rebound in July output is a key factor behind our forecast that not only will overall activity stop declining after the 0.4% drop in the second quarter but that it will rebound in the third quarter to a solid 2.9% annualized pace. Although the Bank of Canada might be encouraged by such a rebound, the ongoing concerns about fiscal imbalances in Europe and the US are continuing to weigh on financial markets. Any upward pressure on the cost of capital and downward pressure on confidence run the risk of dampening growth during 2012. To try and prevent a derailing of the expansion, the Bank of Canada is expected to keep policy very accommodative with the overnight rate expected to be maintained at 1.00% until the middle of 2012.