People shop for produce at the Granville Island Market in Vancouver, on July 20. Canada's inflation rate was up 8.1 per cent in June compared with a year ago.DARRYL DYCK/The Canadian Press
Economists are warning that the probability of a recession in Canada has risen sharply in recent months, although most Bay Street forecasters remain cautiously optimistic that the country can avoid a sustained economic contraction.
The first inflation shock in a generation has spurred the Bank of Canada to push interest rates rapidly higher in a bid to cool demand in the economy and get prices under control. That’s already weighing on the housing market and is expected to dampen consumer spending in the coming quarters as debt-servicing costs rise.
An informal survey of 15 private-sector economists by The Globe and Mail found that most put the odds of a recession in Canada in the next two years between 40 and 50 per cent. A recession is typically defined as two quarters of negative growth.
Only one of the 15 respondents – Craig Wright, chief economist of Royal Bank of Canada – is forecasting a recession next year as his base case scenario.
But many said the risk of an economic contraction has increased due to the persistence of high inflation, a worsening global growth outlook and the Bank of Canada’s aggressive rate hike path, which included a supersized full-percentage-point increase last week.
“Our base case is not yet building in a recession, but we essentially see growth stalling around the turn of the year (with zero growth in Q4 and a small negative in 2023 Q1),” Douglas Porter, chief economist of Bank of Montreal, said in an e-mail.
“The fact that we have one negative quarter already built in [our forecast] suggests that the economy will be on the very cusp of a technical recession early in 2023,” he said.
The Bank of Canada’s latest forecast, published last week, has economic growth slowing dramatically in the second half of 2022 and in 2023. The central bank now expects gross domestic product to grow 1.8 per cent next year, down from its previous forecast in April of 3.2 per cent.
We are at a major turning point in the fight against inflation
Canada’s economy is particularly sensitive to rising interest rates because of high levels of household debt and overstretched housing markets. It is also vulnerable to slumps in the United States, and could quickly follow if the U.S. economy falls into recession.
That said, a number of economists pointed to factors that may make Canada more resilient than other countries. Canadians have, on average, built up significant savings during the COVID-19 pandemic, which could support consumer spending in the face of high inflation and rising interest rates. Meanwhile, higher commodity prices, which are causing havoc in European economies, tend to benefit Canadian exporters.
Matthieu Arseneau, deputy chief economist at National Bank, noted that Canada has outperformed its peers since Russia invaded Ukraine, which caused a global commodity price shock.
“The strength of the resource sector offsets some of the shock to consumers. Governments are raking in a spectacular improvement of public finances, and their spending is showing no sign of moderation,” he said.
Arlene Kish, director of Canadian economics at S&P Global Inc., noted that Canadian consumers have historically been resilient during economic downturns, although consumer spending could shift from discretionary items toward essentials.
“Trade flows are likely going to weaken with softer global demand, but there could be some cushion as Canada replaces exported goods that originated from Russia and Ukraine to parts of Europe,” she added.
The biggest risk to the country’s economic outlook is inflation itself, which hit a new four-decade high annual rate of 8.1 per cent in June.
The longer inflation remains high, the more likely it is to alter people’s behaviour, becoming self-reinforcing in a wage-price spiral. That could lead the Bank of Canada to raise interest rates to punishingly high levels to break the inflationary psychology.
This happened in the early 1980s, when central bankers, led by then U.S. Federal Reserve chair Paul Volcker, sent the global economy into a deep and protracted recession in an ultimately successful effort to bring down inflation.
Most survey respondents expect the Bank of Canada to raise its benchmark rate to a moderately restrictive level of 3.25 per cent or 3.5 per cent in the coming quarters – up from the current rate of 2.5 per cent. However, the bank could push rates up more if inflation remains stubbornly high.
The central bank expects the rate of inflation to peak in the coming months, then decline to around 3 per cent by the end of 2023. The trajectory of inflation remains highly uncertain and many factors that drive inflation are outside the Bank of Canada’s control: global commodity prices – which have begun to come down over the past month – COVID-19 outbreaks, international supply chain problems and the trajectory of the war in Ukraine.
Bank of Canada Governor Tiff Macklem said last week he still thinks a so-called soft landing is possible: inflation comes back down to the central bank’s 2 per cent target without a significant rise in unemployment or major slowdown in economic growth. But he acknowledged that “the path to this soft landing has narrowed because elevated inflation is proving more persistent.”
Mr. Wright of RBC said the Bank of Canada has likely missed the boat on a soft landing. Earlier this month, RBC became the first Canadian bank to forecast a recession in Canada for 2023, although the bank’s economists said the contraction would likely be moderate and short-lived.
“We think the Bank of Canada will raise interest rates high enough to contain inflation and keep inflationary expectations in check, though the hikes will likely come at the cost of a recessionary environment next year,” Mr. Wright said.
RBC puts the odds of a recession in Canada at 90 per cent. On the other end of the spectrum, Bank of Nova Scotia chief economist Jean-François Perrault said the probability of a recession is between 25 and 30 per cent.
Mr. Perrault sees robust consumer spending, supported by a buildup of savings during the pandemic, and a desire to spend on things such as restaurant meals and travel now that public health restrictions have lifted, as being enough to keep the economy out of recession next year.
“The strength of this pent-up demand likely explains some of the resilience in consumer spending in the face of a very sharp drop in consumer confidence, the loss of purchasing power coming from higher inflation and of course higher interest costs,” Mr. Perrault and René Lalonde, Scotiabank’s director of modelling and forecasting, wrote in a note to clients this week.
“These important headwinds to household spending will hold back the pace at which this pent-up demand is resolved, but we predict that pent-up demand will prove to be the more powerful driver of consumption through 2023.”
Craig Alexander, chief economist with Deloitte Canada, said a recession next year is not his base case forecast. But he said businesses should be readying recession contingency plans and preparing for a downturn.
“We can debate about whether there will be an economic slump or recession (it will be one of the two), but regardless of what happens, business and institutional leadership teams need to think about what levers they can pull to respond to economic challenges,” Mr. Alexander said.
“And it isn’t just about cost cutting. The most effective strategies to address turns in the economic cycle involve looking at new technologies, markets, alliances, and investing in talent,” he said.
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