The Canadian economy is headed for a rough patch. Growth has already slowed considerably. Job growth has moderated. Inflation remains stubbornly high. But the pain that households feel today is only going to get worse.
“The path forward looks bleak,” Tiago Figueiredo, macro strategy associate at Desjardins, said in a note.
For a time, the economy proved more resilient than expected. The Bank of Canada’s interest rate hikes piled up one after another. Still, the labor market boomed and GDP continued to expand.
But economic pain was inevitable. Rising inflation has eroded purchasing power and rising interest rates have hit households. Now, cracks have begun to appear in the data, and economists expect those cracks to grow. GDP contracted in the second quarter of this year.
New data next week is expected to show that economic growth was flat in July and perhaps contracted again in August. Some of that can be attributed to specific factors, such as the port strike, including labor actions like the port strike in British Columbia or the wildfires.
But before all that, momentum was fading from the Canadian economy.
That would put Canada on track for two consecutive quarters of negative growth, which would meet the technical definition of a recession.
Frances Donald, global chief economist and strategist at Manulife Investment Management, says we should spend less time debating what to call this crisis and focus more on how it will affect people.
“Even if there are technical factors that prevent two quarters of negative GDP, this economy will feel like a recession to most Canadians over the next year,” he told Breaking:.
How bad are things really?
Experts say there are several factors masking how bad the economy really is. The first is that it typically takes about a year and a half for the economy to absorb the full impact of changes in interest rates.
The Bank of Canada began its rate raising cycle 17 months ago. That means the impact of the fastest and most aggressive interest rate hike cycle in Canadian history is yet to come.
Second, consumption patterns changed during the pandemic and have not fully returned to normal, predictable ways that facilitate economic modelling. During the pandemic lockdowns, Canadians bought a lot of “stuff.” We seize electronics, gym equipment and household items. Now, those same households spend primarily on experiences.
So, newly released retail sales figures show a rebound in July, but a slowdown in August. It’s not as easy to determine how much of that is seasonal or cyclical when all of these other factors push and pull consumers in different directions.
“Consumer discretionary spending is being held back by inflation and rising borrowing costs. Another sign of slow growth for the Canadian economy as the Bank of Canada, at the same time, struggles with above-target inflation,” Robert Kavcic, senior economist at BMO, wrote in a note to clients.
Above all the figures and all the changes floats an unprecedented increase in immigration. Last year alone, more than a million people moved to Canada. That has boosted consumption, but masked some underlying weaknesses.
Donald says all of those factors have combined to make the economy look healthier than it really is.
“We are at the moment when the Titanic hit the iceberg. But the ship did not sink. It seems that we have experienced a shock, but not a problematic one,” Donald said.
“The good news is that, unlike the Titanic, we can heal the economy if necessary by lowering interest rates.”
Where are interest rates headed?
The Bank of Canada paused its series of rate hikes earlier this month. But the central bank said that depended on seeing more progress in the fight to control inflation.
Since then, inflation was much higher than anyone expected. And this time it wasn’t just the costs of gasoline and mortgage interest. So-called core inflation measures, which exclude more volatile components such as the price of gas, rose or remained firm.
Derek Holt, vice president and head of Capital Markets Economics at Scotiabank, says the breadth of price pressures in August is “staggering.” He says the 52 percent basket of the consumer price index has increased four percent month over month at a seasonally adjusted annual rate. Almost two-thirds have increased by more than three percent.
He says recent data challenges the most basic assumptions people have been making about the economy.
“Inflation is cooling, they say. It’s just gasoline costs and mortgage interest that are driving it, they say. The government’s (rather confusing) ‘plan’ is working, they say. The Bank of Canada is obviously done to raise rates, they say. All of which is complete and utter garbage,” he said in a note to his clients.
Holt says the reacceleration of inflation data last month “definitely increases the odds of a rate hike” when the central bank meets again in October.
In a speech this week, Bank of Canada Deputy Governor Sharon Kozicki highlighted the dilemma facing the central bank.
“We are a long way from rate cuts”
“We know that if we don’t do enough now, we’ll probably have to do even more later. And that if we tighten too much, we risk needlessly damaging the economy,” he said at a luncheon in Regina.
He said some volatility in inflation was “not uncommon” and that past rate hikes “will continue to weigh” on economic activity.
None of that is new. The central bank has spent much of the last year and a half talking about balancing the risk between doing too much and causing more pain than necessary and doing too little and allowing inflation to take hold.
But economists like Donald say there has been a shift as the bank begins to think about when and how it will need to start considering lowering rates again to ease the burden on households.
“We are a long way from rate cuts,” he says. “But you could see the exit ramp very far away. And the Bank of Canada is trying to widen that exit ramp to give them some option” if they need it.
She predicts rates will begin to decline again during the first half of next year.
“But for many Canadians there are still a lot of painful things to overcome,” Donald says.