Canadian economy expected to cool off as business cycle concludes

17 October 2018 Authored by Consulting.ca

After experiencing robust economic growth of 3% in 2017, Deloitte Economic Advisory expects the Canadian economy to grow 2% in 2018, cooling further to 1.4% in 2020. Intrinsically linked to US fortunes, Canada’s economy will likewise slow as its southern neighbour approaches the end of the business cycle after a decade of growth.

Canada’s economy is set to cool off, as nothing lasts forever – even strong economic growth. Consumer spending is expected to decrease in 2019 and 2020, depressed by high household debt, rising interest rates, weaker employment growth, and flat real estate markets. Firms are also expected to be more cautious in their business investments, despite the renegotiation of NAFTA.

And since no country is an economic island, Canada will be affected by the downturns expected both globally and in the US. Deloitte projects the global economy to slow to 3.2% growth in 2020 from 2018’s 4% growth rate, while the US economy is expected to dip to well below 2% growth in 2020.

In Canada, consumer spending is set to moderate as Canadians’ debt-to-income ratios have rocketed to sky-high levels, particularly as a result of the heavy real estate borrowing required to purchase a home in Canada’s inflated market. With fixed and variable mortgage rates projected to rise in the near future, Canadians are expected to limit their debt growth as they face rising debt-servicing costs.Canadian economic growth to gear downConsumer spending will also slow due to flatter real estate markets, with more restrictive income stress tests on mortgages, as well as higher interest rates. This will constrain job creation in related markets (construction, materials, etc.) and depress spending on housing-related items like furniture and appliances. Overall, Deloitte projects personal consumption growth to be 2.2% this year, cooling to 1.8% next year and 1.4% in 2020. Consumption accounts for over half of the Canadian economy.

Residential investment is likely to decline slightly this year due to increased regulations and borrowing costs. Business investment in machinery and equipment stalled in Q2 2018, with business cautiousness and weaker growth prospects in North America slowing capital spending. Deloitte expects M&E spending to slow from 8% in 2018 to 3.2% in 2019 and 2.4% in 2020.

Canadian exports are projected to grow to 3% in 2018, slowing to 2.8% in 2019, and 1.7% in 2020. Canada’s pace of export growth will be limited by loss of market share in key international markets. As well, exports will decline as Canada’s biggest trade partner, the US, sees its economy slow in 2020 due to fiscal drag caused by the loss of tax stimulus. Fortunately, the signing of the USMCA averted the US tariffs on the Canadian auto sector that would have been exceedingly damaging to Canada’s economy.Unemployment ratesMeanwhile, unemployment was been pushed to a 40-year low of 5.8% in the first half of 2018, though job creation had stalled temporarily by the end of the summer. The low unemployment rate, however, hasn’t led to particularly strong wage growth (2.6% over the three months ending in August, less than the 3% inflation up to August 2018). Deloitte attributes this, in part, to the limited bargaining power of middle-skill workers for whom there is lower labour market demand.

With little slack in the labour market but tame growth in wages, the Bank of Canada is expected to moderately increase interest rates to a middle ground 2.5-3.5% overnight rate – providing neither stimulus nor heavy brakes to the economy. Overnight rates are projected to rise 25 basis points in 2018, and 75 basis points by the end of 2019. Slower economic growth in 2020 will likely halt further increases in interest rates.

"The signs that the North American economy is in the late stages of a business cycle are all around us, from a record long bull market in US equities to low unemployment rates and rising central bank rates," commented Deloitte Canada's Chief Economist, Craig Alexander. "The negotiation of USMCA reduces the downside risks to the Canadian economy, and economic growth should persist. However, businesses should still prepare for more moderate domestic demand growth and a weaker US economy over the medium term."

Alexander, formerly Chief Economist at The Conference Board of Canada and at TD Bank, was appointed Deloitte Canada’s first chief economist earlier this summer. In the newly created role, Alexander is responsible for producing economic insights to help clients plan for the future – helping them effectively respond to macro forces and changes in economic policy.

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