It’s a question that’s dominated the news cycle, stock market watchers, economic analyses and even Ottawa’s 2023 budget — will Canada’s previously roaring economy coast into a so-called “soft landing” as it slows, or tumble sharply into a recession?
Ongoing calls from a chorus of economists predicting a recession to hit Canada in 2023 have come up against surprisingly strong economic data in the early part of the year, making the tea leaves of an economic downturn especially hard to read.
A recession is a widespread decline in economic activity over a certain period of time – usually defined as two straight quarters of negative growth.
Ottawa’s 2023 budget bases its economic forecast on a consensus of private sector economists.
That document, released March 28, showed that economists’ place the odds of a recession higher than when they were last polled for the 2022 fall economic update.
But if the economy is supposed to be slowing down right now, someone might want to tell the economy.
January’s gross domestic product (GDP) figures outpaced initial estimates from Statistics Canada with 0.6 per cent growth, rebounding from the flat reading in the final quarter of 2022.
Canada’s labour market meanwhile held tight with a 5.0 per cent unemployment rate through the first quarter of 2023. The country’s employers have been in a hiring mood as of late, with net 383,000 positions added since last September.
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James Orlando, senior economist at TD Bank, called Canada’s jobs market a “juggernaut” in a note to clients earlier this week.
A tight labour market is boosting Canadian incomes, he said, which in turn fuels household spending. That’s putting the country on track for two per cent GDP growth in the first quarter of the year, according to TD’s estimates.
Orlando said the surprisingly strong data would likely “worry” the Bank of Canada, which has a careful eye on the country’s economy as it decides where to take its benchmark interest rate next.
The central bank’s policy rate has already risen substantially over the past year, with another decision coming on Wednesday.
While one would think a surprisingly strong economy is “good news,” CIBC’s chief economist Avery Shenfeld said in a note Thursday that the higher that rate goes, the more pressure the Bank of Canada puts on the economy — raising the odds of a possible recession.
“In this topsy-turvy world, good news for the economy isn’t really what we’re looking for. If the slowdown that central banks are aiming at fails to materialize, that could force yet more rate hikes, and risk a harder landing,” he wrote.
So what to make, then, of this mixed bag of economic data and recession forecasts? Here’s what economists are saying about Canada’s recession odds in a “topsy-turvy world.”
Why has the economy been so hot?
Among the factors keeping Canada’s economy so hot through the first quarter of the year was a record number of more than 430,000 new permanent residents coming to the country in 2022.
Stephen Brown, deputy chief North American economist at Capital Economics, explains that while higher borrowing costs might be working to slow Canadians’ spending on an individual basis, because there are simply more Canadians in the country, real GDP has been on the rise even as per capita figures decline.
“That’s helping to offset some of the negative effects of higher interest rates on spending by existing consumers in the economy,” he says.
BMO chief economist Doug Porter also signalled that robust jobs numbers tied specifically to immigration might be enough for the Bank of Canada, which has raised concerns about the country’s tight labour market in the past, to give a pass to Canada’s stronger-than-expected Q1 economic results.
“Given Canada’s fiery population growth, the Bank of Canada is probably more than willing to swallow strong job increases,” he wrote in a note on Thursday.
Digging deeper into the economic data suggests that, like robust immigration numbers, there are other reasons why the Bank of Canada might be able to keep its foot off the gas and avoid tipping the economy closer to a recession.
Some of the explanation for the economy’s hot start to 2023 is a bit literal — January was warmer than average this year, Brown notes, which likely spurred Canadians to visit restaurants and spend more freely elsewhere in the economy that month.
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Another factor boosting the economy has been relief from global supply chains coming back online.
Automotive manufacturing, which has been plagued by delays for years amid supply snarls, has been one such industry kicking into high gear at the start of 2023.
Alongside its interest rate decision on April 12, the Bank of Canada will release a revised forecast for inflation and economic growth.
Shenfeld said that since the weather-related boost was temporary and strong employment and supply side improvements are generally “non-inflationary” fuels for the economy, the central bank won’t feel as much pressure to respond to these factors.
Brown agrees that one strong quarter of economic growth isn’t enough to push the Bank of Canada back into rate-hike mode, with the expected slowing still on the horizon.
“I think it would be happy sitting on the sidelines,” he says.
Reuters polled 33 economists this past week about whether the Bank of Canada will move from its conditional pause on April 12 — all predicted a hold.
‘Cracks’ in the foundation?
Brown says that, in general, “there is always a lot of disagreement” at this part of the recession cycle.
Recessions are not a “linear process” where Canadians stop spending money in tandem, the economy cools for a bit and then “everything ends well,” he says.
Capital Economics is among firms who predict a modest recession in 2023, but Brown says it remains to be seen whether it’s a hard or soft landing.
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He notes that even ahead of the 2008 financial crisis, which ended up the deepest downturn since the Great Depression, some economists had been predicting the United States would skirt a recession.
But when the housing market south of the border collapsed, that was the “shock” that sent economies around the world into recession.
Josh Nye, senior economist at Royal Bank of Canada, says it’s common in periods of rising interest rates that tighter conditions lead something to “break” in the financial sector.
What form could such a surprise take this time around? The recent turmoil in the banking sector following the collapse of Silicon Valley Bank in the U.S. was one such sign that today’s high interest rate environment was revealing “cracks” in the global economy, Nye says.
“Are there other shoes to drop here? I mean that’s simply something that we don’t know,” he says.
For Brown’s part, he looks for signs of stress in Canada’s real estate market, which represents a relatively large proportion of the country’s GDP compared to the U.S.
Canadian homeowners are facing higher mortgage rates today than a year ago, raising the odds that they’ll default on their loans if they face a sudden loss of income.
Brown notes that recent guidance from Canada’s financial services watchdog directing banks and lenders to provide Canadians with ways to offset the burden of higher mortgage rates by, for example, lengthening amortizations, will help “reduce the risk” to the wider economy.
But Canadian households are not the only ones facing higher debt servicing costs with elevated interest rates — so too are developers and commercial property owners.
Homebuilders who are set to finish properties this year are looking to close deals as Canadians face reduced access to credit. Commercial landlords, meanwhile, are renewing credit agreements while vacancy rates rise in some properties amid the new hybrid work environment.
If one or all of these sectors see a steep collapse amid a reduced access to credit, “it presents a risk that there could be a deep recession,” Brown says.
Even without a possible shock, a more general cooling over the coming quarters could be enough to push Canada into a modest downturn, Brown says — or even skirt the technical recession.
While many of the factors keeping Canada’s economy hot in the early part of the year, immigration could be a wildcard in a recession, Brown argues.
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If Canada is able to keep up the current pace of immigration through 2023, Brown says that could help to lift the economy in the months ahead to the point where the country avoids two consecutive quarters of negative GDP growth.
Ultimately, whether specific metrics are hit and how economists arrive at their recession calls won’t matter much to everyday Canadians, who tend to feel economic downturns as job losses or another hit to their income.
With significant uncertainty still on the horizon and continued expectations that Canada’s economy is due for a slowdown, Brown says there’s more pain in store before this economic cycle is over, even if enough things go right for Canada to technically avoid a recession.
“I probably characterize it as a bumpy landing,” he says. “It’s not quite soft, not quite a hard landing, but certainly not a great outcome.”
-With files from Motorcycle accident toronto today’ Anne Gaviola and Reuters