Economic growth has been more resilient than feared in the wake of aggressive interest rate increases last year. Canada’s stalled toward the end of 2022 with a flat GDP growth reading in Q4 the first time the economy has failed to expand since a pandemic-related decline in Q2 2021. But output bounced back 0.3% in January alongside a surge in employment – making a small increase in Q1 look more likely than the small decline we previously expected. Global growth forecasts for 2023 have been revised higher with China emerging from pandemic lockdowns and economic growth in Europe firmer than expected despite the war in Ukraine. And labour markets remain ultra-tight with high (albeit easing) levels of job openings competing for a historically small pool of unemployed.
Still, interest rates impact the economy with substantial lags – and often end up having unintended consequences. Recent turmoil in financial markets has cast doubt on whether the Fed will continue to raise interest rates. The Bank of Canada already moved to the sidelines announcing a pause in rate hikes in January. But higher interest rates will continue to cut into household purchasing power with a lag. Housing markets have continued to retrench, both in Canada and abroad. The global manufacturing outlook has softened, and easing supply chain disruptions and lower (albeit still-high) commodity prices are helping to slow inflation. Against that backdrop, the most likely scenario is still that the U.S. and Canadian economies will both enter mild recessions over the middle-quarters of 2023.
Global manufacturing outlook deteriorating
Source: Haver, RBC Economics Research
More pain to come: softness in consumer demand and hiring is still on the horizon
So far, labour markets have been resilient, but it takes time for higher interest rates to hit consumers’ and businesses’ debt payments. A large share of household borrowing in Canada comes from fixed rate mortgages with payments that don’t reset until contracts are renewed.
The share of household disposable income eaten up by debt payments was still below pre-pandemic levels at the end of last year, but will rise to record levels by the second half of this year. That will be compounded by a sharp pullback in household net wealth as housing markets continue to retrench. With households feeling less wealthy and higher debt payments and prices cutting into purchasing power, consumer spending is likely to slow later in 2023.
We continue to expect unemployment rates to drift higher – to 6.8% in Canada from 5.0% currently by early 2024.
Canadian debt servicing cost increases to lag rate hikes
Source: StatCan, RBC Economics projections
The alternative to a ‘bumpy’ landing might not be pretty
The upcoming recession we expect still sits firmly on the ‘mild’ side of historical downturns. But we don’t expect a bumpy landing for the economy to be avoided altogether. Certainly, there is a chance that broader near-term consumer spending could be stronger and less sensitive to interest rate increases than expected. Labour markets have been very strong, and households accumulated a large amount of savings over the pandemic. But with the supply of goods and services already unable to keep up with demand, stronger spending would result in stickier inflation pressures—and higher interest rates. These rates will cut further into household purchasing power down the road, delaying but not preventing a downturn.
Recent inflation data has been encouraging, particularly in Canada, and the easing in price growth is diluting some of the larger downside risks to the macroeconomic outlook. But in reality, consumer demand probably needs to soften for inflation to return fully to central bank target rates. And the alternative to the relatively mild ‘bumpy,’ economic downturn we expect in 2023 could still look more like a crash landing down the road if substantially higher interest rates, and a larger pullback in economic activity, is required to get inflation fully back under control.
Central banks still close to (or at) the end of this hiking cycle
After launching one of the fastest rate hiking cycles in history in the beginning of 2022, central banks are now debating how much further interest rates need to go. The Bank of Canada moved to the sidelines in January, announcing a ‘pause’ in interest rate hikes to assess the impact of the 425 basis points worth of increases over the prior year (the fastest pace of hikes since the 1990s).
The U.S. Federal Reserve is nearing the end of its tightening cycle. Strong job growth, spending, and upside surprises on inflation had policymakers concerned that the 450 bps of hikes delivered thus far won’t be enough to cool the economy and curb inflation pressures. But recent financial turmoil is a reminder that aggressive interest rate hikes won’t come without costs, and not all of those costs are known or expected. Chair Powell was flagging a higher terminal rate just one week ago but that looks unlikely now given growing financial stability concerns.
GDP growth to resume late in 2023, but unemployment to remain elevated
An immigration-fueled surge in population growth in the wake of pandemic lockdowns will help fill some current gaps in labour markets and will add almost a million consumers to the Canadian population over 2023 and 2024. That boost the production (and consumption) potential of the economy and will help put a floor under economic growth with GDP growth to resume positive, but modest, growth after mid-year declines. Still, we don’t expect those initial increases to be large enough to push unemployment significantly lower in 2024 with central banks cautious about reverting from interest rate hikes to cuts too quickly.
Immigration set to further accelerate in Canada
New permanent residents in Canada, in thousands
Source: StatCan, IRCC, RBC Economics
Provincial Outlook
No parts of the country will be sheltered from the stiffer economic headwinds. We expect growth in all but one province (Newfoundland and Labrador) to slow down materially this year, with a few (Ontario, BC and Quebec) at risk of tipping into recession. We forecast Saskatchewan (+2.0%), Alberta (+1.9%), and Newfoundland (+1.6%) to come out ahead of the pack thanks in large part to strong global commodity markets. Exceptionally high population growth is projected to sustain spending and residential investment out east, keeping provinces in Atlantic Canada growing faster than the national average (+0.6%). Soaring household debt service costs and a sharp correction in the housing market will weigh heavily on the outlook for British Columbia (0%), Ontario (+0.2%), and Quebec (+0.3%).
Real GDP growth
Source: Statistics Canada, RBC Economics
To read the full report and provincial breakdowns, please visit rbc.com/economics
About the authors
As RBC Chief Economist, Craig leads a team of economists providing economic, fixed income and foreign exchange research to RBC clients. Craig is a regular contributor to a number of RBC publications and is a key player in delivering economic analysis to clients and the media through the Economics Department’s regular economic briefings.
Robert Hogue is responsible for providing analysis and forecasts on the Canadian housing market and provincial economies.
Nathan Janzen is an Assistant Chief Economist, leading the macroeconomic analysis group. His focus is on analysis and forecasting macroeconomic developments in Canada and the United States.
Claire Fan is an economist at RBC. She focuses on macroeconomic analysis and is responsible for projecting key indicators including GDP, employment and inflation for Canada and the US.
Rachel Battaglia is an economist at RBC. She is a member of the Macro and Regional Analysis Group, providing analysis for the provincial macroeconomic outlook.
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