Canadian economy stalls as higher interest rates weigh on growth

The Canadian economy has stalled in recent months as higher interest rates weigh on growth, bringing the country to the brink of a mild recession.

Real gross domestic product was essentially unchanged in September, according to a preliminary estimate that Statistics Canada published Tuesday. While the numbers will be revised on Nov. 30, GDP is on track to fall by 0.1 per cent annualized in the third quarter, after a 0.2-per-cent drop in the second quarter.

If those figures hold, Canada would post two consecutive quarters of declining GDP – what some economists refer to as a “technical recession.” Output would also be considerably weaker than the Bank of Canada’s most recent projection, published last week, which expected 0.8-per-cent growth in the third quarter.

The situation is much different in the United States, which last week reported annualized growth of 4.9 per cent in the third quarter, the quickest expansion since the final quarter of 2021.

The Statscan numbers provide further evidence that Canada’s economy is stagnating as higher interest rates curb spending and investment. The Bank of Canada has rapidly raised interest rates – its policy rate stands at 5 per cent, up from 0.25 per cent in early 2022 – to subdue the biggest inflationary surge in four decades. (The bank had previously slashed interest rates to stimulate the economy amid COVID-19-induced lockdowns.)

But as economic activity wanes, analysts on Bay Street are increasingly convinced that the central bank is finished with its rate-hike campaign.

“This is yet one more crystal clear sign that the Bank of Canada should be done hiking,” Benjamin Reitzes, a Bank of Montreal strategist, wrote in a client note. “The potential for a second consecutive negative quarterly GDP reading will cause recession chatter to ramp up quickly. The soft economic backdrop, which still has downside, will drive inflation down over time … it’s just a question of how quickly.”

In August, eight of 20 industrial sectors posted increases in real GDP. (The Statscan report offered detailed figures for August, but just an overall estimate for September.) Services-producing industries edged up 0.1 per cent, while the goods-producing industries fell 0.2 per cent.

Mining and oil and gas extraction jumped by 1.2 per cent in August, although this was partially a recovery from the disruption of forest fires earlier in the year. Manufacturing fell for a third consecutive month, while the hospitality sector slid by 1.8 per cent, with particular weakness at restaurants and bars.

In its latest projections, the Bank of Canada downgraded its outlook for economic growth, though officials are not predicting a recession.

“We’re expecting growth below 1 per cent for the next three, four quarters,” Bank of Canada Governor Tiff Macklem explained at a press conference last week. “Is that a recession? No, it’s not a recession. It’s low positive growth.”

Mr. Macklem said “some small negative numbers” couldn’t be ruled out in the near future – although this wouldn’t necessarily qualify as a recession.

“When people say the word ‘recession,’ I think what they have in mind is a steep contraction in output and a large rise in unemployment. That’s not what we’re forecasting.”

Canada’s labour market has softened in recent months, as seen with declining job postings and a slower pace of hiring. Still, the unemployment rate (5.5 per cent) is low by historical standards. Statscan will publish the next results from its Labour Force Survey on Friday.

The annual inflation rate has fallen to 3.8 per cent from a peak of 8.1 per cent last summer. Despite that progress, the Bank of Canada has warned of various risks to the outlook, including volatile oil prices and sharp increases in housing costs, owing to a supply shortage.

Mr. Macklem told the parliamentary finance committee on Monday that the Bank of Canada could begin cutting interest rates before inflation returns to its 2-per-cent target. The central bank projects a return to target by mid-2025. Many analysts expect rate cuts to start some time next year.

If GDP declines slightly for two consecutive quarters, it could lead to a hearty debate about whether Canada is in recession – particularly if the labour market continues to exhibit strength.

In 2015, for instance, Canada posted two consecutive quarters of GDP decline, owing to a plummet in oil prices that hammered Alberta’s economy. Many analysts referred to the situation as a “technical recession.”

The C.D. Howe Institute did not agree. In 2018, the think tank’s business cycle council took a final vote on the 2015 downturn and narrowly decided it wasn’t a recession. The council said the breadth of the GDP contraction was narrow and that employment rose during the period in question.