Canada to experience mild recession this year, Deloitte says

Canada’s real gross domestic product (GDP) is projected to fall by 0.5% in 2023 and then rebound with 2% growth in 2023, according to an economic outlook report from Deloitte Canada.

The report, which was released to coincide with today's unveiling of the federal 2023-24 budget, notes that elevated uncertainty, a swift increase in borrowing costs, and a US downturn are the key factors driving the predicted recession – which is generally defined as two consecutive quarters of negative GDP growth.

Central banks in the developed world – including Canada – have been raising interest rates to cool overheated economies and quell persistent high inflation. The Bank of Canada moved its overnight rate from 0.25% in March 2022 to the current level of 4.5% in only 10 months.

Inflation was 6.3% in December 2022 and 5.9% in January 2023, still well above the central bank’s 2% target. The Bank of Canada has for now decided to pause and observe if dropping economic output is enough to push inflation down further without more rate hikes.

“While the level of inflation has been coming down in recent months, it’s still too high for comfort, and the Bank of Canada’s pause on rate hikes is contingent on inflation continuing to decelerate in line with their expectations,” said Trevin Stratton, national economic advisory leader, Deloitte Canada. “Keeping in mind the near-term decline in economic output, our forecast does see inflation cooling rapidly throughout the rest of the year.”

Deloitte forecasts inflation in Canada will decline to 3.5% in the second quarter of 2023 and closer to the 2% target in 2024. As a cooling economy brings down inflation, the central bank is expected to start lowering interest rates by the end of 2023 and throughout 2024 to reach the neutral level of 3%  – which neither stimulates nor suppresses economic growth.

The US Federal Reserve, however, is expected to continue hiking rates to 5.25% by June to aggressively target its inflation, which was a slightly higher 6.4% in January 2023.

The anticipated gap between US and Canadian rates will drop the value of the loonie to an estimated average of US$0.726 in the second and third quarters of 2023.

Deloitte thinks the federal budget will be fairly reserved, with just a 1% increase in real government spending on goods and services. This is due to mindfulness of the large debt incurred by pandemic stimulus and concerns over fueling inflation with further spending.

The government is expected to target priority areas such as improving affordability for lower-income Canadians (such as a grocery rebate), increasing transfers to provinces for healthcare, and increasing green incentives.

On the consumer front, confidence and spending is down because of inflation and higher interest rates. Deloitte expects Canadians to continue paring back spending in the short term, especially on vehicles, apparel, and recreation.

Consumer spending is projected to decline at an annualized rate of 0.1% in Q1 23, fall another 0.6% in Q2 23, and then start rebounding in the second half to reach an average of 0.9% growth for 2023.

Moderation of inflation and interest rates is expected to increase real consumer spending by 2.6% in 2024.

Deloitte expects the housing market to reach its nadir in Q3 23, with expected rate cuts at the end of the year and in 2024 driving recovery. High immigration targets will also help preserve Canada’s housing bubble.

The strong labour market will help moderate the severity of this year’s recession. 268,000 jobs were created between November to February, while the unemployment rate is a low 5%. Wage gains remain below inflation.

Slack is, however, emerging in terms of job vacancies – which fell from 6% in April 2022 to 4.2% at the end of 2022. Industries such as transportation, building, and business services are expected to experience a short-term decline in employment levels, pushing unemployment to 5.6% by the start of 2024.

“The good news is the recession we’ve been anticipating is not expected to be as deep as projected last quarter, thanks in part to the continued resiliency of the labour market, which is supporting incomes, and we will see better growth prospects in 2024 and 2025,” Stratton said. “The bad news is that the downside economic risks continue to grow as there are several factors impacting Canada’s economy, like the recent Silicon Valley Bank and Credit Suisse failures, a rapid rise in borrowing costs, and a downturn in the US, which are all adding to a landscape of elevated uncertainty.”