Canada recession: It's coming, RBC predicts, but how long will the downturn last?

Canada is headed towards a moderate recession, but the economic contraction is expected to be short-lived compared to previous recessions, economists with Royal Bank of Canada predict.

The Bank of Canada has been hiking its key overnight interest rate aggressively this year to combat skyrocketing inflation, which surged to 7.7 per cent in May, the fastest rise in nearly four decades and well above economists’ expectations.

With the central bank maintaining its two per cent target, more aggressive moves are expected this month and beyond to bring inflation down by 5.7 per cent. Economists are predicting a 75 basis point hike in July – mirroring the U.S. Federal Reserve’s move in June – and another 50 in September, a Reuters poll suggests.

The forceful strategy, in step with the U.S. Fed, has raised concerns that Canada is headed for a recession, with high borrowing costs leaving Canadian households carrying too much debt particularly vulnerable. Experts say lower income groups have the greatest exposure to the dual risks of inflation and rising interest rates.

According to economists, much of the inflationary pressures are coming from outside Canada, with energy and food prices soaring on the back of supply chain bottlenecks due in part to Russia’s invasion of Ukraine.

“Canada’s economic growth has fired on all cylinders following pandemic shutdowns,” said economists Nathan Janzen and Claire Fan in an RBC article published on Wednesday.

“But a historic labour squeeze, soaring food and energy prices and rising interest rates are now closing in. Those pressures will likely push the economy into a moderate contraction in 2023…Still, by historical standards, we expect the slowdown to be modest.”

Janzen and Fan said strong activity within the travel and hospitality sectors and higher commodity prices are helping to fuel a recovery, but a lack of workers is hampering businesses trying to expand. They note that while there were 70 per cent more job openings last month compared to the same time period prior to the pandemic, employers were competing for nearly nine per cent fewer workers in the job market.

“Soaring prices are cutting into Canadians’ purchasing power at the pump and the grocery store,” they said.

“As the economic contraction plays out next year, [the unemployment] rate will likely rise another one and a half percentage points to 6.6 per cent. These job losses will come at a time when Canadians are already grappling with higher prices and debt servicing costs, factors that have hit lower income households the hardest.”

Meanwhile, a report released on Tuesday by the Canadian Centre for Policy Alternatives (CCPA) found that over the last 60 years, the three times the Bank of Canada managed to reduce inflation by 5.7 per cent through a rapid and aggressive rise in interest rates, a recession followed. But economists at RBC and elsewhere have said there are few alternatives central banks can use to deal with inflation.

“The Bank of Canada now has little choice but to act,” Jazen and Fan wrote.

“Inflation has been too strong for too long and is starting to creep into longer-run business and consumer expectations. Higher inflation expectations can become self-fulfilling, making businesses more likely to pass on cost increases and consumers more willing to pay for them.”

Even without the interest rate moves, slowing growth and demand outside the country will weigh on Canada.

Despite these concerns, RBC believes the recession will be less severe than previous economic downturns.

“Global inflation pressures may soon peak,” the economists predict.

“Prices are still rising too fast and inflation won’t slow sustainably until demand falls. But once that happens, central banks will ease interest rates again…We don’t think it’ll take long to unwind that weakness in 2024 and beyond.”

Graphic by CTVNews.ca Data Journalist Deena Zaidi