By Ketki Saxena
Investing.com – Royal Bank of Canada (TSX:RY) economists have previously and repeatedly forecast a “mild” downturn in the Canadian economy in 2023. And they now have a more refined timeline. RBC economists now believe that Canadians can expect a recession during the second and third quarters of the year, according to a report on Canada’s economic outlook that came out this week.
The report notes, “The upcoming recession we expect still sits firmly on the ‘mild’ side of historical downturns. But we don’t expect a bumpy landing for the economy to be avoided altogether.”
The report cite mortgage renewals, a retrenchment in labour markets, and rising levels of household disposable income - expected to hit a record in Q2 or Q3 of 2023- as key reasons for a Canadian recession within that timeframe.
The report notes, “The share of household disposable income eaten up by debt payments … will rise to record levels by the second half of this year. That will be compounded by a sharp pullback in household net wealth as housing markets continue to retrench. With households feeling less wealthy and higher debt payments and prices cutting into purchasing power, consumer spending is likely to slow later in 2023.”
The report argues that while the Canadian labour market remains robust, the effect of higher interest is not yet being felt, and will also begin to make an impact in late 2023.
“So far, labour markets have been resilient, but it takes time for higher interest rates to hit consumers’ and businesses’ debt payments.” the report noted. “We continue to expect unemployment rates to drift higher – to 6.8% in Canada from 5.0% currently by early 2024.”
Over this period, the impact of interest rates will also begin to be felt to a greater degree on mortgages. “A large share of household borrowing in Canada comes from fixed rate mortgages with payments that don’t reset until contracts are renewed.”
The report also acknowledges a scenario in which labour markets remain robust, boosting household disposable income to debt ratios. However, in this case, the more robust economic growth and consumer spending would add to inflationary pressures - something the Bank of Canada can hardly afford to let happen.
The report notes, “With the supply of goods and services already unable to keep up with demand, stronger spending would result in stickier inflation pressures—and higher interest rates.”
A cooling economy and a retrenchment in the labour market thus appear to be a necessity to cool the more insidious problem of inflation, despite the immediate pain likely to be felt by Canadian consumers.
“Recent inflation data has been encouraging”, the report noted, adding the caveat that “In reality, consumer demand probably needs to soften for inflation to return fully to central bank target rates.”