Taking stock of the Canadian economy — it's complicated
THE CANADIAN PRESS/Justin Tang
Governor of the Bank of Canada Tiff Macklem and Senior Deputy Governor Carolyn Rogers participate in a news conference on the Bank of Canada's rate announcement, in Ottawa, on Wednesday, June 5, 2024.
As the Bank of Canada prepares to unveil its latest rate decision and accompanying suite of forecasts next Wednesday, it provides a good moment to assess the state of the nation’s economy. These quarterly announcements serve as perhaps the most comprehensive barometer of economic health available.
Every three months, a dedicated team of Ph.D. economists immerses itself in a sea of data, employing sophisticated models to project economic conditions for the upcoming two years. This rigorous analysis forms the foundation upon which Governor Tiff Macklem and his governing council base their policy decisions.
What we can expect next week is likely a second interest rate cut in as many months, following the Bank of Canada's reduction of its policy rate in June for the first time in four years. The forthcoming forecasts will likely depict an economy that continues to grow but has hit a soft patch.
That soft patch, however, has a silver lining because it is helping to alleviate inflationary pressures and giving the central bank leeway to gently ease its restrictive stance.
To recap: The recent inflation crisis led the Bank of Canada to implement rate hikes amounting to nearly five percentage points, marking one of the most aggressive tightening episodes in history.
The anticipated lower rates will offer welcome relief for indebted households and an economy burdened by higher borrowing costs. However, it is crucial to recognize that these rate cuts also signify current economic frailty.
How weak is it?
The economy is growing as slowly as possible without tipping into an outright recession. According to revised forecasts released this week, the International Monetary Fund projects Canada’s growth will average 1.3 per cent in 2024, a slight increase from 1.2 per cent in 2023.
While these numbers are slightly above market economists' expectations, they fall just below the Bank of Canada’s April forecast of 1.5 per cent growth for this year, indicating the central bank may revise its forecast downward next week.
Despite not sounding catastrophic, these figures are historically sluggish, representing one of the weakest two-year growth periods in the past century, excluding recessions. In fact, the data show that without the significant surge in population over the past two years, driven by international migration, Canada would likely be in a recession. The country’s population has increased by 2.3 million during this period, growing at more than twice the pace of gross domestic product.
Many of these new arrivals — immigrants, foreign students and temporary workers — have successfully found jobs, which is fueling growth and economic activity. Over the past 24 months, employment has risen by more than 800,000, with 200,000 jobs added this year alone.
However, the strains of a rapidly rising population are evident, particularly in the housing market and increasingly in the job market. The sluggish economy is struggling to keep pace with the growing labour force.
Canada’s unemployment rate has climbed to 6.4 per cent, up 1.4 percentage points since the end of 2022. This type of increase in unemployment is typically associated with recessions. The number of unemployed has grown by about 250,000 in the past 12 months — figures usually seen only during recessions.
Uncertain landscape
It's a peculiar situation. The Canadian economy presents a paradox: strong employment increases, typically a sign of strength, coupled with rising unemployment, a sign of weakness. While the economy is growing, it lags behind the rapid pace of population growth. The pie is expanding, but Canadians are receiving smaller slices.
This dichotomy underpins reports like the one released this week by the Royal Bank of Canada, titled: “Canada’s economy might not be in recession but it feels like one.” Such an environment is challenging for policymakers, who lack historical precedents to guide their decisions confidently.
Given such uncertainty, the Bank of Canada will remain cautious and hold off from dramatic rate cuts unless the economy unexpectedly deteriorates sharply.
Rate path
Economists anticipate a measured pace from Macklem, likely reducing the central bank’s policy rate by another 1.25 percentage points by the end of next year.
For borrowers, this translates to prime lending rates offered by commercial banks falling to just under 6 per cent by December 2025, down from over seven per cent at the start of this year. While that’s not a sharp decline in borrowing costs, economists believe this gradual reduction will spur a robust rebound. The IMF projects Canada will grow 2.4 per cent in 2025, the fastest in the G-7.
This base case scenario is quite favorable. Achieving growth above two per cent with low and stable inflation is an optimal outcome. Exceeding this would require faster productivity growth than our economy is currently capable of producing.
However, there are less favorable scenarios to consider. One possibility is that consumer price inflation fails to return to the Bank of Canada’s two per cent target, slowing the rate reduction timeline.
Another adverse scenario involves a prolonged economic downturn and weak hiring, potentially driving unemployment higher. In this case, the Bank of Canada might accelerate rate cuts to revive activity, although the extent would depend on inflation trends.
The worst-case scenario is a climbing jobless rate coupled with stubborn inflation, a non-standard situation since weak economies typically see falling inflation. But these are unusual times.
