The Canadian economy will slip into a “moderate and short-lived” recession in 2023 as it copes with rising interest rates and lofty inflation, Royal Bank of Canada warned on Thursday.
The recession won’t be as severe as previous downturns, but will see consumer spending slow as households adjust to the strongest price growth in decades, higher costs of borrowing and the loss of wealth, stemming from a slowdown in the housing market, the bank’s report said.
RBC is the first of Canada’s major lenders to predict a recession by 2023. It forecasts that economic output will drop at an annualized rate of 0.5-per-cent in both the second and third quarters of next year. The Canadian economy will manage to eke out real (inflation-adjusted) growth of 0.8 per cent in 2023, RBC forecasts.
The downturn will also lead to job losses, sending the national unemployment rate – now at a record low of 5.1 per cent – to around 6.6 per cent, RBC estimates.
The Bank of Canada and its global peers are aggressively raising interest rates, aimed at curbing demand and knocking down inflation. Canada’s annual inflation rate hit 7.7 per cent in May, the highest since 1983.
The consensus view on Bay Street is that the Bank of Canada will raise its policy rate by three-quarters of a percentage point next week to 2.25 per cent. RBC expects the benchmark interest rate to reach 3.25 per cent by the end of this year.
As monetary policy tightens quickly, global investors are betting that a recession will follow, which has led to a selloff in stock markets and lower prices for commodities, such as crude oil.
“Though higher rates will technically push Canada toward a contraction, the Bank of Canada now has little choice but to act,” wrote RBC economists Nathan Janzen and Claire Fan in their report.
“Inflation has been too strong for too long and is starting to creep into longer-run business and consumer expectations. Higher inflation expectations can become self-fulfilling, making businesses more likely to pass on cost increases and consumers more willing to pay for them (and demand higher wages).”
Earlier this week, Bank of Canada surveys of businesses and consumers showed that inflation expectations are continuing to rise, especially so for the next two years.
In an April forecast, the Bank of Canada said the economy would grow 4.2 per cent this year and 3.2 per cent in 2023, after adjustments for inflation. The central bank will issue a new forecast on Wednesday, alongside its rate decision. Private-sector forecasters have been pencilling in slower growth as inflation troubles linger.
While higher interest rates are “necessary to tame inflation,” the RBC authors said an economic downturn “can be reversed once inflation settles enough for central banks to lower rates” again.
Canada’s labour market has seen a full recovery of jobs since the pandemic started, and now companies are grappling with a protracted shortage of workers. RBC said the unemployment rate is almost a full percentage point lower than what it considers a neutral level, or one that doesn’t spur higher inflation.
RBC predicts job losses in 2023 will be “modest” by historical standards. If the unemployment rate hits 6.6 per cent, as the bank forecasts, that would be roughly two percentage points lower than the peak of the 2008-09 recession.
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