Canada is facing growing economic headwinds as key trading partners teeter on the brink of recession, piling worries about trade and commodity prices on top of concerns about the domestic economy.
Global growth is being hit on multiple fronts. Central banks around the world, led by the U.S. Federal Reserve, are raising interest rates at the fastest pace in decades – intentionally slowing their economies to fight inflation.
The European energy crisis escalated this week, with the apparent sabotage of the Nord Stream pipelines that ship gas from Russia to Europe. Meanwhile, Britain is in the midst of a currency and bond market meltdown, which pushed the Bank of England to intervene in markets Wednesday and warn of a “material risk to U.K. financial stability.”
The Organization for Economic Co-operation and Development said earlier this week it expects the world economy to be US$2.8-trillion smaller in 2023 than it projected a year ago. And things could get a lot worse, the OECD warned, if a cold winter in Europe leads to energy rationing and new gas supplies fail to materialize.
None of this bodes well for Canada’s trade-oriented economy. Most debate about a potential recession here revolves around domestic issues, including the impact of Bank of Canada rate hikes on the housing market and the amount of savings consumers have built up.
But with forecasters projecting a sharp slowdown in economic growth through the rest of 2022 and into 2023, a fall in foreign demand for Canadian exports or further drops in commodity prices could tip the economy into recession.
“The growth we’re calling for is so slim, that given the risks that are out there, there’s really not a whole lot of margin for manoeuvre,” said Stuart Bergman, chief economist at Export Development Canada.
The crucial variable for Canada is what happens in the United States. There, the outlook has darkened over the past week as the Fed doubled down on its efforts to curb demand in the U.S. economy and get prices under control.
The Fed raised its benchmark interest rate by 0.75 percentage points last Wednesday, to a range of 3 per cent to 3.25 per cent. The rate hike was expected. But updated projections showed policy makers expect to push the Fed Funds rate to between 4 per cent and 4.5 per cent by the end of the year – considerably higher than previously forecast.
“That materially raises the risks that the U.S. economy has a hard landing. And if the U.S. has a hard landing, I think it’s very hard for Canada not to have one as well,” said Craig Alexander, chief economist at Deloitte Canada.
Even Fed chair Jerome Powell acknowledged the central bank was pushing monetary policy into risky territory. “No one knows whether this process will lead to a recession or, if so, how significant that recession would be,” he said in a news conference after last week’s rate announcement.
A U.S. recession would hit a range of Canadian exporters, particularly those tied to interest-rate-sensitive sectors. Lumber and building supply companies would be slammed by a slowdown in American home construction. Automakers and other durable goods manufacturers would be hurt by a pullback in U.S. discretionary spending.
This could be cushioned somewhat by a weaker Canadian dollar. The currency has already lost ground against the U.S. dollar as investors have flocked to U.S. assets as a safe haven, and markets have bet the Fed will raise interest rates more than the Bank of Canada does. A weaker Canadian dollar, in turn, makes Canadian exports more attractive to American buyers.
“The dominant effect is still likely to be the weakening in demand. So Canadian exports will still soften,” Mr. Alexander said. “But the fact that the exchange rate is lower means that Canadian exports won’t fall as far.”
Beyond the U.S., the growth picture is even more dire. China’s economy is expected to grow at the slowest pace in decades this year (excluding 2020 and the COVID-19 shock), as the country struggles with strict pandemic-control measures and a real estate crash.
In Europe, the war in Ukraine and Russian sanctions have sent natural gas and electricity prices soaring. That’s squeezing consumers and making energy-intensive businesses unprofitable, pushing many European Union countries, as well as Britain, toward a period of stagflation: the painful combination of low growth and high inflation.
The OECD now expects the euro area to grow just 0.3 per cent in 2023, down from a projection of 1.6-per-cent growth in June. The German economy is expected to contract 0.7 per cent next year, while the British economy is expected to post no growth.
The energy crisis in Europe presents a mixed outlook for Canadian trade. Some companies will suffer from a drop in demand. But Canada’s trade, broadly speaking, benefits from high energy prices.
“Commodity exporters generally are benefiting at this point from tight global supplies and record high prices across much of the commodity complex,” said Mr. Bergman of EDC, noting that Canadian farmers, miners and energy producers have done well this year.
“And because many countries, especially in Europe, are looking for energy security … exporting these sources are going to offer opportunities for growth,” he said.
Enbridge’s recent US$1.5-billion investment in the Woodfibre LNG terminal in Squamish, B.C., is one such bet on growing global demand for liquefied natural gas. The federal government, for its part, is keen on exporting hydrogen to Germany through East Coast ports, although the infrastructure for this has yet to be built.
These, however, are long-run bets. In the short term, swings in commodity prices could have a bigger impact on trade, and many commodity prices are in retreat. The price of a barrel of West Texas Intermediate crude oil, the North American benchmark, fell below US$80 this week, from a high of US$122 in June. The price of copper, often considered a bellwether for the world economy, has fallen more than 30 per cent since April.
Much depends on how the Organization of the Petroleum Exporting Countries responds to declining global demand for oil.
If OPEC countries, led by Saudi Arabia, curb production, that could keep oil prices relatively high, to the benefit of Canadian energy producers. But other geopolitical factors – including the fate of the Iran nuclear control talks and further limits on Russian oil and gas exports – could also play a major role in energy prices.
“We expect oil to be in for a period of extreme heightened volatility with prices increasingly disconnected from supply demand fundamentals and more driven by headline risk,” EDC’s Mr. Bergman said.
EDC is not yet calling for a recession in Canada or the U.S., and Mr. Bergman said he expects trade to support the Canadian economy through the coming economic turbulence. But he acknowledged the odds of a soft landing are growing increasingly narrow.
“It’s like a bicycle that’s going really, really slowly,” Mr. Bergman said. “It’s fast enough that it’s still staying upright, but it’s kind of wobbling. If it hits a pebble, it could be knocked over. … And there’s a tonne of pebbles around.”