Canada’s economy started the year stronger than many expected, but that doesn’t mean a downturn isn’t in the cards in the coming months, according to an RBC Economics report.
“Economic growth has been more resilient than feared in the wake of aggressive rate hikes last year,” said the report’s authors, led by RBC chief economist Craig Wright.
“Yet interest rates affect the economy with significant lags – and often end up having unintended consequences.”
The most likely scenario remains that the US and Canadian economies will both enter mild recessions by mid-2023RBC Economics
The impact of higher borrowing costs has been fully felt in interest rate-sensitive sectors such as real estate, but it has not yet fully weighed on consumer spending.
In addition, the tight labor market, China’s easing of harsh pandemic restrictions and strong growth in the US economy have helped boost Canadian growth.
The Bank of Canada has put its rate hikes on hold for now, but the longer rates stay high, the more “pain to come,” the report says.
“Higher interest rates will continue to cut into household purchasing power with a lag. Housing markets have continued to decline, both in Canada and abroad. The global manufacturing outlook has softened, easing supply chain disruptions and lower (albeit still high) commodity prices are help to curb inflation,” it says.
“On that basis, the most likely scenario remains that the US and Canadian economies will both enter mild recessions by mid-2023.”
RBC also points out that Canadians will feel less wealthy as home prices fall and higher debt payments eat into disposable income, prompting them to rein in spending later this year.
The road ahead is likely to be bumpy
What type of economic landing Canada experiences will depend on how sticky inflation is and how much the central bank needs to step up its fight to bring inflation down from here, the report says.
In January, Canadian inflation eased to 5.9 percent year-over-year, but that’s still about three times the Bank of Canada’s target.
RBC’s baseline expectation is a “mild” downturn, but says there is a chance that household spending and the labor market will remain robust in the near term, resulting in the potential for more rate hikes.
“And the alternative to the relatively mild ‘uneven’ economic slowdown we expect in 2023 could still look like a crash landing down the road if significantly higher interest rates and a bigger pullback in economic activity are required to bring inflation back up completely under control,” the report said.
Restoration in late 2023
In addition to mid-year weakness, the expected increase in population as the federal government ramps up immigration could push the economy back into growth mode, RBC said.
“An immigration-driven increase in population growth in the wake of pandemic shutdowns will help fill some current labor market gaps and will add nearly one million consumers to the Canadian population during 2023 and 2024,” the report said.
“It increases the production (and consumption) potential of the economy and will help put a bottom on economic growth with GDP growth to resume positive but modest growth.”
Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.
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