Canada can dodge a recession, but it could still happen; here's why

Predicting if a country will slip into a recession can be extremely difficult.

For example, on March 15, RBC’s Thought Leadership Group predicted that the country was heading into a "mild recession" in mid-2023.

This prediction has yet to materialize amid the surprisingly strong job market.

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Today, I’ll outline some reasons Canada might avoid a recession and some risks that could contribute to one. First, let’s take a quick look at Canada’s history with recessions.

What is a recession?

A recession is a term economists use to denote a period of widespread declining economic activity.

As the economy contracts, these economic downturns are typically characterized by:

• Decrease in gross domestic product (GDP)
• Reduced employment
• Reduced spending and investment activity

After the economy experiences two consecutive quarters of negative GDP, economists label the downturn as a recession. The duration and severity of a recession can vary.

During these periods, sectors may contract at different rates, with some potentially still growing, albeit at a slowed pace.

Some of the factors that can trigger a recession include:

• High inflation
• Increasing interest rates
• Reduced consumer confidence
• Geopolitical events
• Natural disasters and global economic crisis

When was the last recession in Canada?

The last recession in Canada occurred in the first quarter of 2020, according to the C.D. Howe Institute, as the global pandemic plunged the country (and many others) into a state of financial crisis.

However, both employment and real GDP began recovering by the late summer of 2020.

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There were fears of another wave in the pandemic thanks to COVID-19 variants emerging in 2021. However, the economy remained strong as Canadian real GDP increased by 4.6 percent and employment increased by 4.8 per cent between 2020 and 2021, according to Statistics Canada’s Q4 quarterly economic and trade report.

In total, Canada has experienced five recessions since 1970:

• October 1974 - March 1975
• June 1981 - October 1982
• March 1990 - May 1992
• October 2008 - May 2009
• February 2020 - April 2020

Is Canada going into a recession?

Keeping track of key indicators, such as employment rates, consumer spending, and GDP, can give consumers time to prepare and policymakers a chance to try to prevent an impending recession.

Canada’s real GDP remained relatively unchanged throughout April, May, and June, according to Statistics Canada’s monthly GDP report, indicating a resilient economy. Employment rates also remain strong.

Since 2021, Canada has not experienced two consecutive quarters of negative GDP growth, meaning that our country is not in a recession. Given the current data, it’s possible that our country may be able to avoid a recession altogether.

Why Canada could dodge a recession

Here are a few of the reasons why Canada could avoid a recession and stay strong, despite some of the more pessimistic predictions.

Its diverse economy

Canada has a diverse economy and doesn’t rely on a single sector for its economic success. Some of the strongest economic sectors include:

• Energy
• Manufacturing (automobiles, aerospace, food)
• Professional services
• Technology
• Agriculture
• Tourism
• Banking and finance
• Real estate

Even if one or multiple sectors go through periods of contraction, other sectors may remain steady or even expand.

Strong banking sector

A strong banking sector can improve consumer trust, and Canada’s banks are large employers that actively contribute to the economy while remaining stable.

Additionally, Canada has one of the world’s most accessible banking systems, as 99 per cent of adults in the country have a bank account, according to the Canadian Bankers Association.

Government fiscal policy

From fiscal stimulus packages to increasing interest rates, the Canadian government isn’t afraid to intervene in an effort to prevent a recession. For example, the Bank of Canada’s recent interest rate hikes have helped decrease inflation rates over the past few months.

Trade Diversification

Trade diversification refers to the expansion of trade relationships to reduce reliance on a single trade partner, such as the United States. This means the country won’t be as strongly affected by economic events within its trade partners’ countries.

While the US remains a strong trade partner for Canada, the country has also pursued other partnerships, including:

• The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP): a free trade agreement among eleven Pacific Rim countries aiming to reduce tariffs, strengthen economic ties, and promote trade and investment across the region.
• The Comprehensive Economic and Trade Agreement (CETA): a free trade agreement between Canada and the EU.

Both of these free trade agreements aim to reduce trading barriers, which promotes easier market access between countries and can lead to increased job creation and business development.

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What could contribute to a recession?

That being said, a recession is not completely out of the picture. Here are a couple of negative factors that could contribute to a recession.

High household debt

Canada’s household debt is rising, and the debt service ratio (which measures the portion of borrowers’ income that goes toward debt) steadily increased from 13.45 in Q1 of 2022 to 14.90 in Q1 of 2023, according to Statistics Canada.

This means that Canadian families are using a larger portion of their earnings to cover their loan and mortgage payments now than they were last year. Last year, for every $100 they earned, they spent about $13.45 to repay debts. This year, they're spending $14.90 out of every $100 earned on those debts.

To counteract increasing debt, consumers may begin spending less, which could lead to economic contraction.

Tightening monetary policy

In an effort to reduce inflation, the Bank of Canada has been steadily increasing its policy interest rate, which now sits at five per cent.

While decreasing inflation is good, interest rate hikes result in higher interest rates for mortgages, auto loans, small business loans, credit cards, and other financial products. This can cause consumers to put off borrowing and buying, which can negatively affect the economy.

The verdict is still out

All things considered, the Canadian economy remains resilient and has significantly recovered from its most recent recession in 2020. While many economists predicted a recession in 2023, the country has yet to experience one as we move into the year's fourth quarter.

While the verdict is still out for a potential economic “hard landing,” I remain optimistic that Canada can still avoid a recession.

Though for your personal finances, I always recommend to hope for the best and plan for the worst. To prepare for the worst case scenario of a severe recession, be sure you have adequate emergency savings, and try to expand on your income sources.

Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.