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Economic Outlook Canada Q4 2023: Sluggish Growth Ahead


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Economic Outlook Canada Q1 2024: Growth Is Set To Continue Slowing

Economic Outlook Canada Q4 2023: Sluggish Growth Ahead

S&P Global Ratings expects the Canadian economy to have subpar GDP growth this year and in 2024. What started as a mild contraction in the second quarter--as strikes and wildfires hindered activity--is just the beginning of a drawn-out sluggish growth path for the next several quarters as the economy begins to feel the impact of high interest rates.

We revised down GDP growth for this year by 0.3 percentage points to 1.2%, and expect a similar 1.2% growth for next year (unchanged from June forecast). We expect domestic demand to contract 0.7% this year and only expand by 0.4% next year.

The unemployment rate rose by 0.5 percentage points to 5.5%, since the beginning of the year. While some of it has to do with the increased labor force participation rate that has come with population boom, the hiring pace has also slowed. With demand slowing alongside more people in the workforce, unemployment is likely to increase and average 6% next year.

The Bank of Canada (BoC) said the job market needs to loosen more before it can be confident that inflation will return to the 2% target. In fact, wage growth is still elevated and inflation remains well above the central bank's target range, with the last mile of disinflation proving difficult. In August, headline inflation edged up to 4.0% from 3.3% in July, on the back of a gasoline price surge and higher shelter costs increase. The core inflation measure climbed back up to 4% year-over-year and is running at a 4.5% three-month annualized basis. The Bank of Canada kept the overnight rate at 5.0% in its last monetary policy meeting, but with a hawkish tilt. We have penciled in one more rate hike coming by the end of this year as inflation remains too high for policymakers' comfort.

Table 1

S&P Global Ratings' Canada economic forecast overview
September 2023
2019 2020 2021 2022 2023f 2024f 2025f 2026f
Key indicator
(annual average % chg)
Real GDP 1.9 -5.1 5.0 3.4 1.2 1.2 1.5 1.8
change from June (ppt.) -0.3 0.0 -0.2 -0.1
Domestic Demand 1.1 -5.6 6.9 4.9 -0.7 0.4 1.5 1.5
Consumer spending 1.5 -6.1 5.0 4.8 2.0 1.0 1.9 1.8
Nonresidential fixed investment 3.1 -9.4 4.5 4.6 1.3 1.2 1.4 1.4
Residential investment -0.7 5.0 14.9 -11.2 -12.8 -0.9 1.0 1.8
Government Consumption 1.0 1.3 6.4 2.0 0.2 -0.7 -0.2 1.4
Real Exports 2.7 -8.8 1.5 2.9 5.0 2.8 2.4 2.2
Real Imports 0.4 -9.1 8.0 7.5 -1.3 0.5 2.1 1.5
CPI 2.0 0.7 3.4 6.8 3.9 2.2 2.5 2.1
Core CPI 1.8 1.2 2.9 5.6 3.7 2.4 2.1 1.9
Unemployment rate % 5.7 9.7 7.5 5.3 5.4 6.0 5.4 5.1
Exchange rate per US $ 1.33 1.34 1.25 1.30 1.33 1.32 1.29 1.27
Housing Starts ('000s) 207.4 218.9 273.1 261.9 230.3 198.4 204.1 210.6
10-year Government Bond % 1.73 1.08 1.80 2.86 3.37 3.29 2.87 2.84
Note: All percentages are annual averages, unless otherwise noted. Core CPI is consumer price index excluding energy and food components. f--Forecast. Sources: StatCan, Bank of Canada, S&P Global Market Intelligence Economic Simulink, S&P Global Ratings Economics' forecasts.

Subpar Growth Began In The Second Quarter

Canada's economic growth stalled in the second quarter after a strong rebound in the first quarter, suggesting the economy is losing steam. Part of the weakness in the second quarter can be attributed to 'transitory' factors, including the federal government workers' strike in April and wildfire-related disruptions to mining sector output. Household spending appeared to be declining, particularly the durable goods, offsetting the higher spending on semi-durable and non-durable goods. In addition, services spending, which had been resilient previously, slowed in the second quarter. Non-residential investment also continued to have strong growth momentum, increasing 2.5% over the previous quarter, after expanding 1.4% in the preceding quarter (see chart 1).

Chart 1


In addition, massive forest fires across many provinces (particularly Quebec), in the second quarter, hit operations in several mines in the region and disrupted significant natural resources output. Primary energy production declined 1.8% year over year in June--the lowest level of energy output since February 2022. Production of crude oil and equivalent products dipped 1.4% to 22.1 million cubic meters in June. Per S&P Global Market Intelligence, the devastating fire destroyed more than 3.3 million hectares across the country, affecting more than 100,000 people under evacuation orders.

The heat and flames caused significant losses to agriculture, construction, accommodations, food services, and transportation, in addition to mining and quarrying activities. According to the government of Canada, costs of fire suppression ranging from C$800 million to C$1.2 billion per year. We expect third quarter growth to remain low but positive, a slight reversal from stalled activities in the second quarter.

Residential investment has been weighing ongrowth for the past five quarters, amid sharp rise in mortgage rates. Housing affordability also remained significantly poor as housing prices increased. However, the federal government recently announced it was eliminating the goods and services tax (GST) on the construction of new rental apartments, effective immediately. This policy aimed to incentivizemore newly constructed homes and increase housing affordability.

The Canadian housing market was slower in the middle of the third quarter as higher interest rates slowed housing demand. Home resales fell 4.1% in August, from the previous month, to 460,140 units on a seasonally adjusted annualized basis, after a 0.5% drop in July, according to the Canadian Real Estate Association (CREA). Meanwhile, the supply conditions improved slightly in August, as new listings increased 0.8% on a monthly basis. The MLS home price index rose 0.4% in August, following a 1.0% gain in July. This was the lowest monthly gain since April. Notably, aggregate home prices have dropped around 15.6% from its unsustainable level since February 2022, before starting to move up again in March 2023 (up 7% since).

However, with tightening credit, and headwinds from external demand, the latest available high frequency data suggests that growth will likely remain muted in the second half of the year. Statistics Canada's advanced estimateof July GDP as well as retail sales for July and August (advance estimate) suggested a weak rebound so far in the third quarter, after a 0.2% decline in the second quarter.

The manufacturing purchasing managers' index ( PMI) from S&P Global Market Intelligence also suggested deteriorating operating conditions in manufacturing. The headline index registered 48.0 in August, down from 49.6 in July--the lowest reading since June 2020--underpinning persistent weakness in output and new orders. A PMI reading of under 50 indicates a contraction. Trade flows also continued to moderate in recent months, suggesting sluggish global demand, especially from the U.S. and Europe (which together represent more than 80% of Canada's total exports). Given the high share of exports as a share of GDP (28%), a slowdown in global demand definitely weighs on economic activity (see chart 2).

Chart 2


Some Loosening In A Still "Tightish" Labor Market

Meanwhile, the labor market remained solid, though the pace of job gains eased to some extent. The monthly employment gain averaged 31,000 in the past three months, and 40,000 year to date. Conversely, labor supply has increased sharply, averaging 58,000 per month throughout 2023. Labor supply outpaced labor demand this year, slowing sticky wage growth.

The unemployment rate was 5.5% in August, (unchanged from the previous month), the highest reading in the past one and a half years. Although average hourly earnings growth remained solid in August, it ticked lower on a year-over-year basis to 4.9% from 5% in July (see chart 3).

Chart 3


The share of unionization to total employment has been declining but remained elevated at close to 29% in 2022 (see chart 4)--significantly above the U.S. level of 10.1%. Unionized jobs usually pay higher wages together with registered pension plans. The unionization is usually higher for public sector enterprises, compared with the private sector.

In August, employees with union coverage were paid 10% higher wages (C$35.68/hour) compared with employees without union coverage (C$32.56/hour). More importantly, the unions currently continue to have higher bargaining power, which is good for the workers, but not for the central bank that wants wage pressures to subside.

Chart 4


Inflation Needs To Come Down Further For BoC To Pause Rate Hikes

Inflation in Canada had come a long way from last June's peak of 8.1% to this June's 2.8%. While victory appeared to be around the corner, it has since reversed its direction with inflation rising amid increasing gasoline prices and shelter costs. Higher mortgage costs due to rising interest rates contributed just below half of the total inflation in August. In fact, core inflation also stayed above expectations in August. The BoC's preferred CPI-trim and CPI-median rose 3.9% and 4.1%, respectively, in August, higher than market expectations (see charts 5 and 6). However, the good news from the August CPI print was from groceries, which moderated to a still high 6.9% year over year from 8.5% in July.

The central bank's latest monetary policy meeting hinted it would raise rates again if needed. We expect another 25 basis point hike in interest rates in the next quarter given elevated core inflation, but we do not expect another hike after that given the weakening economy. We think the weakness in the economy will lead the BoC to start cutting rates beginning in the second quarter of next year. Meanwhile, we expect core inflation to average 3.7% this year and 2.4% in 2024, as price pressures subside because of dwindling demand.

Chart 5


Chart 6


The views expressed here are the independent opinions of S&P Global Ratings' economics group, which is separate from but provides forecasts and other input to S&P Global Ratings' analysts. S&P Global Ratings' analysts use these views in determining and assigning credit ratings in ratings committees, which exercise analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.

This report does not constitute a rating action.

Primary Credit Analyst:Satyam Panday, San Francisco + 1 (212) 438 6009;
Research Contributor:Debabrata Das, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai

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