People shop for produce at Granville Island Market in Vancouver on July 20. The inflation rate in Canada rose 8.1% in June compared to a year ago.DARRYL DYCK/The Canadian Press

Economists warn that the likelihood of a recession in Canada has risen sharply in recent months, although most Bay Street forecasters remain cautiously optimistic that the country can avoid a sustained economic contraction.

The first inflationary shock in a generation prompted the Bank of Canada to rapidly raise interest rates in an effort to calm demand in the economy and bring prices under control. This is already weighing on the housing market and should dampen consumer spending in the coming quarters as debt service costs rise.

An informal poll conducted by the Globe and Mail of 15 private sector economists found that most of them put the odds of a recession in Canada at 40 to 50 percent in the next two years. A recession is generally defined as two quarters of negative growth.

Only one of 15 respondents – Craig Wright, chief economist at the Royal Bank of Canada – predicts a recession next year as a base case scenario.

But many said the risk of an economic contraction had increased due to persistently high inflation, a deteriorating outlook for global growth and the Bank of Canada’s aggressive rate hike path, which included an oversized percentage point increase last week.

“Our base case isn’t building into a recession just yet, but we’re essentially seeing growth stagnate around the turn of the year (with zero growth in Q4 and a small negative in Q1 2023),” Douglas Porter, Chief Economist of the Bank of Montreal, said in an e-mail.

“The fact that we have a negative quarter already built in [our forecast] suggests that the economy will be on the verge of a technical recession in early 2023,” he said.

The latest forecast from the Bank of Canada, released last week, predicts a dramatic slowdown in economic growth in the second half of 2022 and into 2023. The central bank now expects gross domestic product to grow by 1 .8% next year, down from its previous April 2020 forecast. 3.2 percent.

We are at a major turning point in the fight against inflation

The Canadian economy is particularly sensitive to rising interest rates due to high levels of household debt and overstretched housing markets. It is also vulnerable to crises in the United States and could quickly follow if the US economy falls into recession.

That said, a number of economists have pointed to factors that could make Canada more resilient than other countries. Canadians have, on average, accumulated significant savings during the COVID-19 pandemic, which could support consumer spending in the face of high inflation and rising interest rates. Meanwhile, higher commodity prices, which are wreaking havoc on European economies, tend to benefit Canadian exporters.

Matthieu Arseneau, deputy chief economist at National Bank, noted that Canada has outperformed its peers since Russia invaded Ukraine, causing a global shock to commodity prices.

“The strength of the resource sector is offsetting some of the shock to consumers. Governments are reaping a dramatic improvement in public finances and their spending shows no signs of moderating,” he said.

Arlene Kish, director of the Canadian economy at S&P Global Inc., noted that Canadian consumers have always been resilient during economic downturns, although consumer spending may shift from discretionary items to essentials.

“Trade flows are likely to weaken with weaker global demand, but there could be some cushion as Canada displaces exported goods from Russia and Ukraine to parts of Europe,” he said. she added.

The biggest risk to the country’s economic outlook is inflation itself, which hit a new four-decade high annual rate of 8.1% in June.

The longer inflation stays high, the more likely it is to alter people’s behavior, becoming self-sustaining in a price-wage spiral. This could cause the Bank of Canada to raise interest rates to extremely high levels to break inflationary psychology.

It happened in the early 1980s, when central bankers, led by US Federal Reserve Chairman Paul Volcker, plunged the world economy into a deep and prolonged recession in an ultimately successful effort to make lower inflation.

Most survey respondents expect the Bank of Canada to raise its policy rate to a moderately restrictive 3.25% or 3.5% over the next few quarters, up from the current rate of 2 .5%. However, the bank could raise rates further if inflation remains stubbornly high.

The central bank expects the inflation rate to peak over the next few months and then decline to around 3% by the end of 2023. The path of inflation remains highly uncertain and many factors fueling inflation beyond the control of the Bank of Canada: commodity prices – which have begun to decline over the past month – the COVID-19 outbreaks, international supply chain issues and the trajectory of the war in Ukraine.

Bank of Canada Governor Tiff Macklem said last week he still believes a so-called soft landing is possible: inflation returns to the central bank’s 2% target with no increase significant drop in unemployment or a major slowdown in economic growth. But he acknowledged that “the path to that soft landing has narrowed as high inflation proves more persistent.”

RBC’s Wright said the Bank of Canada likely missed the mark on a soft landing. Earlier this month, RBC became the first Canadian bank to predict a recession in Canada for 2023, although the bank’s economists said the contraction was likely to be mild and short-lived.

“We believe the Bank of Canada will raise interest rates high enough to contain inflation and control inflationary expectations, although the hikes will likely come at the cost of a recessionary environment next year,” he said. Mr. Wright.

RBC assesses the chances of a recession in Canada at 90%. At the other end of the spectrum, Bank of Nova Scotia chief economist Jean-Francois Perrault said the probability of a recession is between 25% and 30%.

Mr. Perrault considers robust consumer spending, supported by an accumulation of savings during the pandemic, and a desire to spend on things like restaurant meals and travel now that public health restrictions have been lifted, to suffice. to keep the economy out of recession next year.

“The strength of this pent-up demand likely explains some of the resilience of consumer spending in the face of a very sharp decline in consumer confidence, loss of purchasing power from higher inflation and, of course, at higher interest costs,” said Perrault. and Rene Lalonde, director of modeling and forecasting at Scotiabank, wrote in a note to clients this week.

“These significant headwinds for household spending will dampen the rate at which this pent-up demand is resolved, but we expect pent-up demand to prove to be the strongest driver of consumption through 2023.”

Craig Alexander, chief economist at Deloitte Canada, said a recession next year was not his baseline forecast. But he said businesses should prepare contingency plans for a recession and prepare for a downturn.

“We can debate whether there will be an economic crisis or a recession (it will be one of the two), but whatever happens, the management teams of companies and institutions must think about the levers they can act to meet economic challenges,” said Mr. Alexander.

“And it’s not just about cutting costs. The most effective strategies for dealing with turning points in the economic cycle are to look at new technologies, markets, alliances and to invest in talent,” he said.

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