The bad economic times have only just started

The Canadian economy is headed for a rough patch. Growth has already slowed considerably. Job growth has moderated. Inflation remains stubbornly high. But the pain households are feeling today is only going to get worse.

“The path forward looks bleak,” Tiago Figueiredo, a macro strategy associate with Desjardins, said in a note.

For a while there, the economy proved more resilient than expected. The Bank of Canada’s interest rate hikes piled up one after another. Even so, the jobs market boomed, GDP continued to expand.

But economic pain was inevitable. Soaring inflation has eroded purchasing power, and climbing interest rates have clobbered households. Now, cracks have begun to appear in the data, and economists expect those cracks to grow. GDP contracted in the second quarter of this year.

Next week, new data are expected to show economic growth flat-lined in July and perhaps contracted again in August. Some of that can be chalked up to specific factors, such as the port strike including labour actions like the port strike in B.C. or wildfires.

But before any of that, momentum was clearing being sapped out of the Canadian economy.

That would put Canada on track for two consecutive quarters of negative growth, which would meet the technical definition of a recession.

Frances Donald, the global chief economist and strategist at Manulife Investment Management, says we should spend less time debating what to call this downturn and focus more on how it will impact people.

“Even if there are technical factors that avert two quarters of negative GDP, this economy will feel like a recession to most Canadians, for the next year,” she told CBC News.

How bad are things, really?

Experts say there are several factors masking just how bad the economy really is. The first is that it usually takes about a year and a half for the full impact of interest rate changes to get absorbed into the economy. 

The Bank of Canada began its rate-hiking cycle 17 months ago. That means the impact of the fastest, most aggressive interest rate hiking cycle in Canadian history is still to come. 

Second, consumption patterns changed during the pandemic and haven’t fully reverted to normal, predictable ways that make economic modelling easier. During pandemic lockdowns, Canadians bought a lot of “stuff.” We snatched up electronics, gym equipment, household wares. Now, those same households are primarily spending on experiences. 

So, retail sales figures just released show an uptick in July, but a slowdown in August. How much of that is seasonal or cyclical isn’t as easy to determine when all these other factors are pushing and pulling consumers in different directions.

“Discretionary consumer spending is getting held back by inflation and surging borrowing costs. Another sign of sluggish growth for the Canadian economy while the Bank of Canada, at the same time, grapples with above-target inflation,” Robert Kavcic, senior economist at BMO, wrote in a note to clients.

Hovering above all the numbers and all the changes is an unprecedented surge in immigration. More than a million people moved to Canada last year alone. That has driven consumption, but masked some underlying weaknesses.

Donald says all those factors have combined to make the economy look healthier than it really is.

“We are in the moment between when the Titanic hit the iceberg. But the ship has not sunk. When it seems as though we’ve experienced a shock, but not a problematic one,” said Donald.

“The good news is that, unlike the Titanic, we can heal the economy if we need to  by lowering interest rates.”

Where are interest rates headed?

The Bank of Canada paused its series of rate hikes earlier this month. But the central bank said that was contingent on seeing further progress in the fight to rein in inflation.

Since then, inflation came in much hotter than anyone expected. And this time it wasn’t just gasoline and mortgage interest costs. The so-called core measures of inflation, which strip out the more volatile components, such as the price of gas, all rose or held their ground.

Derek Holt, vice-president and head of Capital Markets Economics at Scotiabank, says the breadth of the price pressures in August is “astounding”. He says 52 per cent of the consumer price index basket is up by four per cent month over month at a seasonally adjusted annual rate. Nearly two-thirds is up by more than three per cent.

He says the recent data challenge the most basic assumptions people have been making about the economy.

“Inflation’s cooling, they say. It’s only gasoline and mortgage interest costs that are driving it, they say. The government’s (rather unclear) ‘plan’ is working, they say. The Bank of Canada is obviously done raising rates, they say. All of which is complete, utter, rubbish,” he said in a note to clients. 

Holt says the re-acceleration in last month’s inflation data “definitely ups the odds of a rate hike” when the central bank meets again in October.

In a speech this week, Bank of Canada deputy governor Sharon Kozicki highlighted the dilemma the central bank is facing.

‘We are a long way from rate cuts’

“We know that if we don’t do enough now, we will likely have to do even more later. And that if we tighten too much, we risk unnecessarily hurting the economy,” she told a luncheon in Regina.

She said some volatility in inflation was “not uncommon,” that past rate hikes “will continue to weigh” on economic activity.

None of that is new. The central bank has spent much of the last year and a half talking about balancing the risk between doing too much and causing more pain than was necessary and doing too little and letting inflation get entrenched.

But economists such as Donald say there’s been a shift as the bank begins to think about when and how it will have to start looking at bringing rates back down to ease the burden on households.

“We are a long way from rate cuts,” she says. “But, you could see the off ramp in the very far distance. And the Bank of Canada is trying to widen that off ramp to give them some optionality” should they need it.

She’s forecasting rates will start to come down again during the first half of next year.

“But for a lot of Canadians, there’s a lot that’s still a lot of pain to get through,” says Donald.