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Toronto-Dominion Bank chief economist Beata Caranci says their inflation numbers 'are coming down because we have a consumer cycle that basically completely stalls out next year.'Tijana Martin/The Globe and Mail

Next year will be a “make-or-break year,” according to Toronto-Dominion Bank chief economist Beata Caranci. That’s when the full impact of the Bank of Canada’s interest rate hikes, which started in March, 2022, will hit the economy. For more insights on TD’s outlook, The Globe and Mail recently spoke with Ms. Caranci, who shared her forecasts on the economy, inflation, interest rates and the housing market.

According to Bank of Canada’s recent Monetary Policy Report, growth in real gross domestic product is forecast to come in at 1.2 per cent in 2024 and 2.4 per cent in 2025. TD’s economic forecast is calling for 0.5 per cent growth in 2024 and 1.3 per cent in 2025. Why the more conservative expectations?

A key difference between our forecast and the Bank of Canada’s is the consumer profile. We have consumer spending slightly contracting in the first half of 2024 and low through the rest of the year, which means you have a weak hand-off going into 2025. And that’s largely related to the lagged effect of past interest rates. It often takes about seven quarters from when you raise interest rates to when you start to see the full effect on consumer behaviour. That effect really starts to come through as we get into next year.

The other factor, which I don’t know how they factor into their forecast and maybe we’re the ones who are too low on that estimate, is the population flow. If we continue to see strong population growth, you could have people being conservative on spending, but the aggregate is still showing quite a bit of growth.

We think 2024 is going to be the make-or-break year, where you get the headwind from interest rates colliding with: Do we see employer fatigue on hiring? We think that peak moment happens next year. In 2025, you’re back in the recovery stage.

The Bank of Canada’s recent Business Outlook Survey revealed expectations for wage growth of 4.5 per cent over the next year. What’s your outlook?

It wouldn’t be that much different. Typically, when you have inflation sustained at 2 per cent, wage growth is usually around 3, 3.5 per cent. So, if you’re saying wage growth will be 4, 4.5 per cent, you’re also saying inflation will not be 2 per cent.

You anticipate inflation will fall to 2 per cent by mid-2025. How can inflation fall to this level when there are drivers such as healthy wage growth, high household wealth, a strong labour market, persistent supply chain challenges and high immigration. As well, we’ve seen oil prices rebounding. Is this an ambitious forecast?

Our inflation numbers are coming down because we have a consumer cycle that basically completely stalls out next year. We also have a job market that stalls out. If you have demand stall out, then there’s not much pricing power for companies.

You’re expecting the overnight rate to peak at its current level of 5 per cent with the Bank of Canada cutting the overnight rate in the second quarter of 2024, taking it down to 3.5 per cent by the end of 2024, and 2.25 per cent in 2025. If this forecast doesn’t play out the way you expect, how might it be revised?

The 5 per cent terminal rate may end up being 5.25 or 5.5 per cent, depending on whether the consumer and job market show that slowing-down pattern.

On the flip side, the higher you go, the more tension you’re putting into household finances in a heavily-levered economy. That doesn’t necessarily change the end point, the 3.5 per cent for next year, it may just change the timing of when the bank cuts.

I guess the question is have we lost the sensitivity of households to interest rates and it’s a little too early to say if that has happened. We’re going to know in the second half of this year because we’re getting to the point where it should be really encroaching on people’s finances.

No evidence of that yet?

A little bit of evidence if you look at things like auto financing and subprime lending, you’re seeing a rise in delinquency rates, so people on the margin are responding, but not seeing it outside of those unique areas.

In your continuous analysis of incoming economic data, would the bias be to the upside, with the overnight rate not falling all the way down to 2.25 per cent?

Yes, and that’s based on the population growth. Our thought is if the population strength continues at the same pace that we saw last year, we would likely be pushing that number up to 2.5 per cent, possibly higher.

How much higher?

Adding up to 50 basis points to it so it’ll be between 2.5 and 2.75.

TD’s long-term economic forecast shows that over the next five years home prices are expected to increase at a healthy rate of between 2 per cent and 4 per cent for any given year. However, given the tight housing supply, mortgage rates that may be at or near a peak and strong housing demand from immigration, could this price forecast be too conservative?

Yes, that’s an absolute possibility.

The reason we have prices the range that you mentioned is because when you look at affordability, at a point, it gets more difficult to create demand, to afford houses. Basically, affordability shuts people out of the market. Therefore, it’s hard to sustain prices at 5, 6 per cent growth.

When we forecast home prices, the model tries to put affordability at a level that matches what demand could be supported at that affordability level. To your point, if you continue to get high population flows, the affordability metric is going to get a lot worse and new numbers could be higher.

This report has been edited for length and clarity.

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