Canada’s economy is heading toward a recession as virus, oil prices take bite out of growth

Open this photo in gallery:

Canada’s economy is careening toward recession as the COVID-19 outbreak weighs on business activity and consumer spending, raising the threat of layoffs and bankruptcies in the coming months.

The unfolding downturn is shaping up to be swift and sharp, as Canada and other countries take increasingly drastic steps to slow the spread of the novel coronavirus that causes COVID-19.

Coronavirus guide: The latest news on COVID-19 and the toll it’s taking around the world

Should I cancel my plans? How to get social distancing right in the coronavirus outbreak

Exports are bound to weaken – not only because of a big drop in oil prices, but softening demand from key trading partners. Household spending is tightening as consumers restrict their purchases to the essentials. And debt-laden businesses are finding themselves under financial pressure as their revenues take a hit.

As leaders and health professionals encourage Canadians to avoid travel, gatherings and other aspects of daily life, many companies suddenly can no longer count on routine business to keep cash flows intact.

On Friday, Royal Bank of Canada and Canadian Imperial Bank of Commerce said the country will slip into a recession as economic growth turns negative in the next two quarters.

“You kind of hope you're wrong [with that forecast], but I fear we are right,” said RBC chief economist Craig Wright.

CIBC said both Canada and the United States will likely join “a growing list” of nations that experience an economic contraction. “Stretching out the period in which the disease spreads, while essential in preventing an overrun medical system, lengthens the period in which the economy feels a bite,” CIBC economists said in a report.

Financial leaders are taking action to blunt the hit to the economy and ensure the financial system continues to function smoothly.

The Bank of Canada made an emergency rate cut on Friday to protect the economy against “negative shocks” from the outbreak and lower oil prices. The bank’s overnight lending rate has now been lowered by a full percentage point in just more than a week, and many analysts expect another round of cutting that would take the rate to 0.25 per cent, matching a record low.

“It is clear that the spread of the coronavirus is having serious consequences for Canadian families, and for Canada’s economy,” the bank said in a statement. “In addition, lower prices for oil, even since our last scheduled rate decision on March 4, will weigh heavily on the economy, particularly in energy intensive regions.”

Meanwhile, Finance Minister Bill Morneau said Friday that a “significant stimulus package” would arrive next week. Canada’s banking regulator also cut the industry’s “stability buffer” by 125 basis points, a move that frees up roughly $300-billion for banks to lend out.

And as part of the government’s plan to prevent smaller businesses from running out of cash, Export Development Canada and Business Development Bank of Canada will boost their loans by $10-billion, echoing a strategy used during the 2008 financial crisis. But Ottawa has yet to provide details, including whether it will provide cash to the two Crown corporations or whether they will issue the loans from their existing funds.

Still, such stimulus measures are unlikely to keep Canada from falling into a recession, RBC said earlier Friday, noting the eventual recovery could be tepid because of “the blow to household confidence.”

“We hope because the labour market’s been so tight that firms hold onto their workers, knowing how difficult it was to get the best and brightest when the economy was strong,” said Mr. Wright. “But there’s still going to be some layoffs and hours worked will probably be cut, and that all translates into hits on the income front.”

As such, spooked consumers are poised to deliver a shock to Corporate Canada.

Already, the airline and tourism industries are reeling as travellers cancel hotel and flight bookings, major events get postponed and people stay at home. The Canadian government on Friday asked residents to avoid all non-essential travel outside the country.

Earlier this week, Calgary’s WestJet Airlines said it is cutting its seat capacity by 12 per cent, along with freezing spending and hiring, while Montreal’s Transat AT is seeking government help to avoid layoffs as its sales plunge. Global airline revenue could plummet more than US$100-billion because of the virus outbreak, an industry group said.

The Canadian auto industry had already seen a weak sales trend and was hoping for a rebound this year.

“Now the coronavirus has thrown that all into mayhem,” said Dennis DesRosiers, president of DesRosiers Automotive Consultants.

Dealers worry that coming months could be rough as consumers pare back on big-ticket items.

“Everyone is on edge in terms of what may happen as we move forward,” said Denis Ducharme, president of the Motor Dealers' Association of Alberta. “If it's normal human nature, I would anticipate that we'll probably see a very slow period until lots of things get rectified.”

The Canadian energy industry is bracing for yet another slump. Oil stocks were punished this week, after Saudi Arabia slashed its crude prices when the Organization of the Petroleum Exporting Countries failed to agree on production cuts.

Cenovus Energy Inc. and other producers have cut their capital spending plans, while the budgets of oil-reliant provinces – such as Alberta, Saskatchewan and Newfoundland – will take a major revenue hit from an extended period of low prices.

The restaurant industry could also be hurt as customers hunker down at home.

Steam Whistle Brewing in downtown Toronto cancelled its annual St. Patrick’s Day party, which drew 1,400 people last year. “We realized we just couldn’t be responsible for anything that potentially put our customers at risk,” said chief executive officer Andy Burgess. “I’ve made a lot of decisions this week that didn’t maximize our cash flow.”

In the event of a recession, Canada’s large banks could face soaring loan losses, as borrowers have trouble servicing and refinancing debt and overleveraged companies face insolvency. A major hit to bank earnings could send ripples through the broader economy if banks curtail lending to troubled sectors such as energy and hospitality.

Bank of America Merrill Lynch analyst Ebrahim Poonawala is predicting a 40-per-cent drop in earnings per share for Canada’s five largest banks in a “stress/recession scenario,” because of loan losses and margin compression from lower interest rates.

The impact on Canadian banks could be more significant than in 2008-09 financial crisis, Mr. Poonawala wrote in a note to clients on Friday.

“The consumer (and as a result the housing market) is highly vulnerable to a turn in the job market given elevated debt levels; this could lead to a worse credit loss experience during the next downturn,” he said.

The national household debt burden – more formally known as the ratio of credit market debt to disposable income – stands at 176.3 per cent, Statistics Canada said Friday. In other words, Canadian households owe $1.76 for every dollar of after-tax income.

While the debt burden has levelled off in recent years, it remains near a record high, and it could come under pressure this year given looser interest rates and the prospect of lower income due to job losses or fewer work hours.

“Further acceleration in credit growth amid slowing income gains poses a risk and may renew the buildup of the already-high financial vulnerabilities,” said Toronto-Dominion Bank economist Ksenia Bushmeneva in a client note.

CIBC said Friday that Canada’s jobless rate could rise to 7 per cent from its current 5.6 per cent. Job losses could have disastrous consequences for part-time or gig workers who aren’t covered by Employment Insurance benefits.

“We hope to see some support from the federal government next week to ease the pain on businesses so they’re not pressed to fire people quickly or cut hours dramatically,” said Mr. Wright. “And for those [workers] that are impacted, [offer] some support for income lost.”

With a file from Patrick Brethour

Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.