Monthly Economic Letter
You have questions... we have answers!
What a year! 2023 can justly be described as a rollercoaster ride. As we head into 2024, economic uncertainty continues to top the list of concerns of both households and businesses. To help you see things a little more clearly, once again this year, the January edition of the Economic Letter answers the five questions most frequently asked of BDC economists.
1. Are we in a recession?
A recession refers to a significant drop in economic activity that spreads across the entire economy and lasts for more than a few months. Recessions are a normal part of the business cycle and Canada’s economy is definitely showing signs of a slowdown—GDP fell in the third quarter, the unemployment rate is rising and high interest rates are hurting growth in certain sectors. However, the economy is not in recession.
Rather, it’s catching its breath after overheating in the aftermath of the pandemic. The current slowdown is necessary to cool inflation and restore sustainable growth. Patience will be required before the economy regains momentum. Until then, we're faced with an economy that can best be described as stagnant, not in recession.
We expect the start of 2024 to be similar to the end of 2023 with anemic or even slightly declining growth. The economy should regain some momentum in the second half of the year to finish the year with annual growth of 0.9%.
2. Will interest rates rise again?
The Bank of Canada has maintained the status quo since July, keeping its key rate at 5.0%, and we don’t expect rates to go higher from there. Instead, we believe rates could begin to fall as early as June, although the Bank of Canada has given no indication of when or how quickly it will cut.
By mid-year, we expect the economy to have slowed sufficiently for pressure on domestic production capacity to ease, setting the stage for rate cuts. Still, interest rates will have to remain higher than they’ve been in the past decade to achieve the Bank of Canada’s inflation target of 2%.
Barring a major shock to the economy, the policy rate should start falling in mid-2024 and close the year at around 3.5%. Ultimately, the Bank of Canada should bring the policy rate down to around 2.5%, which is the neutral rate, but this is unlikely to happen before 2025.
3. Do high interest rates pose a significant risk to household finances?
Canadian household debt is high. On average, Canadians owe $1.82 for every dollar of disposable income they earn. Mortgage debt accounts for nearly 75% of total outstanding household debt in the country.
Since March 2022, almost half of all mortgage holders have seen their payments go up because of higher interest rates. This proportion will rise to two-thirds by the end of 2024, and the median increase in payments over the 2023-26 period will be around 20%.
We have seen an increase in the share of loans in arrears for certain types of financing, but, in general, this is a return to long-term, pre-pandemic trends rather than a generalized problem. All in all, high interest rates will crimp the budgets of many households over the next few years, but the situation is unlikely to deteriorate much further because the job market remains robust and interest rate cuts are just around the corner.
4. What can we expect for the Canadian housing market?
Several factors come into play when predicting the direction of the residential market in 2024. In the short term, the market depends on external conditions such as the economic outlook, uncertainty and, of course, the direction of interest rates.
Financing costs are the predominant factor holding back demand currently. Since interest rates now appear to be headed down, we can expect a rebound in activity this year. However, it will take some months for the market to regain a vigorous pace of growth.
In the longer term, the supply of housing will need to increase more rapidly to create a balanced market and restore affordability. Prices should resume their upward trend by the end of the year.
5. What are the implications of record population growth for the Canadian economy?
Population growth has reached a record high. In the third quarter, Canada saw an increase of over 430,000 people. To put that number into perspective, the federal government's immigration target for the whole of 2023 was 485,000.
This population growth presents opportunities for small and medium-sized businesses. It's a new pool of potential consumers and workers for entrepreneurs. Unemployment has risen in recent months across the country, partly as a result of the growing pool of available workers, coupled with the slowdown in economic activity.
However, there also an inflationary risk associated with demand generated by this large influx of newcomers, particularly for housing and public services. This could make the Bank of Canada’s fight against inflation harder, forcing the bank to keep rates higher for longer than expected.
The economy holds up even as the slowdown become more noticeable
The Canadian economy showed resilience at the start of the fourth quarter despite strong headwinds from inflation and high interest rates.
Real GDP remained unchanged for a third consecutive month in October, holding steady at 0%. Statistics Canada anticipated growth of 0.1% in November, which would have meant the economy put in a positive 1.4% showing from January to November, compared with the same period in 2022.
For all of the fourth-quarter, growth appeared to be below the Bank of Canada’s +0.8% annualized forecast. However, a gain of +0.4% compared with the third quarter (according to our forecast) would have allowed the country to avoid two consecutive quarters of negative growth, the definition of a technical recession.
Canadian households remain cautious going into 2024
Growth in 2024 will essentially depend on the health of consumer finances. Coming out of 2023, there was no shortage of reasons why households would want to be cautious in their spending this year.
Weakening financial markets and housing values led to a reduction in Canadian household wealth in the third quarter. At the same time, financial liabilities, consisting mainly of mortgage and non-mortgage debt, continue to rise, albeit at a much slower pace than in recent years.
As a result, household net wealth declined in the third quarter. Still, the ratio of household debt to disposable income fell to 181.6%, meaning households held $1.82 of credit market debt for every dollar of disposable income, a considerable reduction from the peak of $1.87 in the second quarter of 2022.
Household finances remain generally healthy across the country, but the loss of wealth associated with the drop in the value of financial and real estate assets could weigh heavily on consumption in the current climate. People spend less when their wealth decreases and the current uncertainty about the economy’s direction has consumers increasingly worried about the future.
As a result, households are socking away more money into savings and are more inclined to postpone discretionary purchases. With consumer spending already slowing for several months now, consumer confidence low and savings on the rise, spending will likely remain tepid in the months ahead.
Inflation remains above target
The latest data indicate that price growth in Canada maintained the same pace in November as in October, at 3.1% year-on-year. Overall, the inflation picture was little changed in November, with several indicators remaining above the upper limit of the Bank of Canada’s target range (1-3%).
Inflation excluding food and energy edged up to 3.5% (+0.1 percentage points compared with the October report). In basic expenditure categories, price growth was stronger, though still falling. Food costs rose by 5.0% and housing costs by 5.9%, compared with 5.6% and 6.1%, respectively, in October.
The Bank of Canada monitors a wide range of indicators to assess the extent of inflation pressures. The bank's preferred measures of core inflation were unchanged in November on a year-on-year basis. However, short-term measures (annualized three-month change) continue to move closer to the bank’s 2% target.
The bank is expected to keep its key interest rate steady at 5.0% once again in its January announcement. The slowdown in economic and labour market growth is set to continue over the coming months, providing the bank with the necessary confidence that inflation is headed to within its target range in the first half of the year. Canadians could therefore benefit from their first interest rate cut as early as mid-2024.
No job creations nor cuts to conclude 2023
The economic slowdown that has been brewing since last year has not had a dramatic impact on the labour market so far. In December, employment held steady, so did the unemployment rate at 5.8%.
Canada's population grew by 430,000 in the third quarter alone, almost as much as the federal government's official target for permanent residents for the whole year. The recent rise in the unemployment rate could, therefore, accelerate in the coming months, even without any major layoffs.
Although more than 235,000 Canadians retired last year, job vacancies continue their downward trend.
In October, there were just over 670,000 vacancies across the country. Entrepreneurs are still facing labour shortages, but an increase in available workers and the economic slowdown should help businesses meet their hiring needs this year.
The impact on your business
- All in all, entrepreneurs should expect the start of this year to be much the same as the end of 2023. Growth has slowed because of high interest rates, but the economy remains well placed to avoid a recession.
- Canada didn't see much notable progress on inflation this autumn, but the Bank of Canada is unlikely to raise interest rates any further. We still expect the central bank's next move to be a mid-year rate cut.
- The influx of newcomers and a slower economy mean competition for staff should ease in the coming months. However, the economy should start to regain momentum at the end of 2024, and shortages of skilled personnel could quickly reappear. Part-time, casual or internship work are good ways to attract new staff for your longer-term needs.
U.S. economy loses momentum, but remains on track
An impressive growth acceleration in the U.S. economy to 4.9% in real terms in the third quarter will clearly not be repeated in the fourth quarter. However, the U.S. continues to show considerable strength with forecasts for the fourth quarter growth hovering around 2.0%.
Overall, 14 of the 22 industrial groups contributed to GDP growth in the third quarter. Despite high interest rates, GDP in goods-producing industries rose 10.2%, and in services 4.1%. Renewed momentum in residential investment underpinned the construction industry, which was responsible for 13.3% of GDP growth in the quarter, while consumer spending supported the retail sector, which alone contributed almost 28% to third-quarter growth.
Consumer spending remains high
Real consumer spending rose again in November, compared with October (+0.3%). Real household disposable income had stagnated in the third quarter, but posted a solid increase of 0.4% in November, on top of October's 0.3%. U.S. households were thus able to spend more while also increasing their savings.
Personal savings as a proportion of disposable income climbed to 4.1% in November at the same time as real consumption increased by 2.7%.
U.S. inflation comes increasingly under control
While the U.S. consumer price index eased only slightly in November to 3.1% from 3.2% in October, the annual change in the personal consumption expenditure price Index—the inflation measure favoured by the U.S. Federal Reserve—dropped to 2.6% in November.
So, despite the cautious tone adopted by Federal Reserve officials, who are increasingly trying to counter market expectations of an interest rate cut, falling inflation seems to be well established south of the border, suggesting a cut could come sooner rather than later.
The U.S. economy is less sensitive to interest rate movements than Canada's and U.S. monetary policy appears to have been sufficient to bring inflation close to the central bank’s target without unduly hurting economic growth. Unfortunately, the same cannot be said for Canada at this stage, given the marked economic slowdown underway in this country.
Fed watchers believe it will prove increasingly difficult for it to maintain its key rate at the current level of 5.25%-5.50%, whether or not there are signs of weakness in the real economy. Thus, the Fed rate could fall back to 3.75%-4.0% by the end of 2024, but rates should remain at their current level at least until the summer.
Slower job growth continues
The U.S. labour market had another strong year in 2023. However, fewer new jobs have been created in recent months. In December, 216,000 new workers were added to the 2023’s impressive balance sheet, bringing the total gain for the year to 2.7 million.
However, the unemployment rate held steady to 3.7% in December. Average hourly wage growth, which was still very high in December at 4.1%, should return closer to 3% in 2024.
The impact on your business
- The U.S. economic outlook remains favorable, although the pace of growth is expected to slow in 2024. Job creation continues but at a less robust rate, which will temper wage gains.
- All in all, Canadian companies should expect U.S. demand to slow in the coming months, despite a loonie that remains favorable to Canadian exports.
- Canadian companies supplying the residential market could, however, enjoy some renewed momentum in the second half of the year. Activity in the housing sector is already picking up thanks to a decline in long-term interest rates.
Oil prices could gain ground to start the year
Oil prices have fallen sharply since September, losing more than US$20 from highs approaching US$100 a barrel. Brent closed 2023 at around US$76 a barrel and WTI at US$71.
Upward pressure in 2024
While market factors were pushing prices down at the end of 2023, much to the delight of consumers and central bankers, oil producers should get some relief in early 2024.
The International Energy Agency (IEA) recently revised upwards its oil demand forecasts for this year. According to the IEA, global demand will increase by 1.1 million barrels per day (Mb/d). This revision reflects the continued resilience of the U.S. economy, which will partly offset a slowdown in demand from other major economies.
Financial markets are now expecting the Federal Reserve to lower its trend-setting interest rate as early as March. Lower U.S. rates would put downward pressure on the dollar against other currencies, which, in turn, would make oil more affordable elsewhere in the world because crude is traded in U.S. dollars.
Although the Fed is trying to tamp down market anticipation for a first rate cut early in 2024, oil price gains are likely to remain limited until rate cuts and renewed optimism are felt in the real economy.
China keeps the brakes on major gains
In contrast to the improved outlook in the U.S., China remains mired in a deflationary slowdown. Without massive intervention from Beijing, the economic situation is unlikely to improve in the short term for the world's largest importer of crude. Sluggish Chinese demand, and the uncertainty that goes with it, should keep oil investors on their toes at the start of the year.
On the supply side, even if the Organization of the Petroleum Exporting Countries and its allies (OPEC+) maintain the production cuts announced in early December, non-OPEC+ producers are expected to increase supply. In fact, the IEA expects non-OPEC producers to add 1.2 Mb/d to global supply, covering the expected growth in demand.
The bottom line...
In the short term, prices are likely to hover around their current range, but relief for oil consumers could be short-lived. A recovery in global demand is expected to begin in the second half of the year once the world's major economies start to cut interest rates.
The waiting game of the Bank of Canada
The Bank of Canada will probably maintain the status quo at its next rate announcement in January while waiting for inflation to reach its target. In fact, for the second consecutive month, inflation stayed at 3.1% in November 2023. The good news is that some parts of the inflation, on which the Bank’s monetary policy has little impact, have also continued to ease such as food inflation.
In 2024, we expect inflation to continue to trend lower and slowly get anchored in the 1-3% target zone. If all goes well, most probably the Bank of Canada’s next move will be a rate cut. The Bank is expected to lower the policy rate close to 3.5% by year-end, before cutting further to reach neutral rates of 2.5% in 2025.
The loonie gains slight strength in December
The Canadian dollar strengthened in December, averaging at US$0.74. While the currency has gained some strength recently, the long-term outlook remains muted. In 2024, the U.S. economy is expected to outperform its major trading partners in 2024 which would keep any gains in exchange rate capped fluctuating between US$0.72 and US$0.75.
Business leaders remain pessimistic
The CFIB's confidence index for the year ahead remained below the critical 50 mark despite a slight improvement from 45.6 to 47 between November and December 2023.
Since the start of the tightening cycle, businesses kept on losing confidence as their expectations of further deterioration in the economic outlook grew. We expect a pick up in confidence by mid year as inflation eases further.