The Decibel - What’s in store for Canada’s economy in 2024

Episode Date: January 8, 2024

Inflation has been rising, interest rates have accelerated at record pace, and the cost of living has been weighing on us all. Canada’s economy has been flirting with a recession since the start of the pandemic, but we may have avoided the worst of it.So what’s in store for 2024? Will there be any reprieve? The Globe’s economics columnist and reporter David Parkinson is on the show today to tell us what this year’s financial forecast looks like.Questions? Comments? Ideas? Email us at [e-mail]

Last year was marked by persistently high food inflation, high interest rates, and high costs of living. It's not a surprise that many of us might be feeling financially stressed. So, can we expect some relief now that 2024 is here? Dave Parkinson is an economics columnist for the Globe's report on business, and he'll break down the major themes that will influence the economy this year. I'm Mainika Raman-Wilms, and this is The Decibel from The Globe and Mail. Dave, thanks so much for being here today. Hey, thanks for having me. So in 2023, last year, we heard a lot about inflation worries and high interest rates.

These are big topics of conversation. So I think before we get into what we should pay attention to this coming year, I guess, how would you just compare the economic mood of last year to 2024? Okay, well, you know, I'm a guy of the 70s. I'm going to check my mood ring here. It is no longer reading black, but it's kind of somewhere between gray and amber. For people who don't know between gray and amber. For people who don't know what gray and that means we're still, we're sort of off the deep misery, but there's still reason for apprehension. Things, at least on the inflation and interest rate front, look a lot better than they did a year ago. Inflation is now around 3%. We're still aiming

to get it down to two, but 3% is a lot better than the peak, which was 8%. So things are starting to look up there. Interest rates have probably peaked, and we're looking towards 2024 to start to see those declines. So things are looking in the right direction, but they're far from certain. Okay. Okay. So not black anymore, but dark gray and amber. We're not in a great spot. Let's say amber. It's kind of mild apprehension. Okay. Mild apprehension. Okay. Well, keeping that in mind then, I guess, what are the themes that you're looking out for in 2024? You know, a lot of them are going to be very similar to what we were looking at in 2023.

They're going to look a little different than they did in 2023, but we're still going to be talking about a lot of the same major things. I mean, first of all, we still haven't conquered inflation. We're getting close, but the last bit of inflation that's left in there is going to be the tough bit to get out. So that's going to be a major focus and that's going to be something we've got to keep our eye on. A second major theme, and it's quite closely related, but interest rates. We've spent the better part of two years seeing them go up. We've finally seen them level off late in 2023. This is the year that they start to come down. That will take some pressure off the whole system, but we really don't know when they'll start to come down or by how much. And there's a lot of factors that can intervene. And you know what?

We're still not off the recession watch. So, you know, it's still possible we could have a recession. It's going to be a very slow year for growth. So those are sort of the major themes we're looking at. Okay. All right. So let's break these themes down kind of one by one. Let's just start with inflation because this is the big one, right?

So in November, Canada's inflation rate hit 3.1%, which is getting close now to that 2% target that the Bank of Canada wants. Could we actually see inflation get down to 2% this year? I think it's possible we'll actually see a number near 2% at some point during the year. But remember, these numbers go up and down from month to month. There's some volatility in them on a regular basis, especially when you start putting things like gasoline and food prices into them. They tend to fluctuate quite a bit. So it's entirely possible once we're down below three, which we probably will be soon, that 2% could be in sight. But the key for the

Bank of Canada is, can it stay there? And so they'll be looking a lot of underlying indicators within the inflation numbers to say, broadly, are we headed towards 2%? They'll be looking at core inflation measures. Those are still too high. Those are still more like three and a half. And remind us, when you say core inflation, what are you referring to there? Yeah, core inflation, it's a concept of sort of filtering out the month to month noise in the inflation numbers and looking at the proportion of inflation that really covers the entire economy. And that's what the central bank cares about. They don't care if gas prices go up from month to month or go down from month to month. They're not terribly worried about sort of fluctuations

that can happen because of one-offs, because of weather-related delays in shipments that can cause prices to go up in food, say. But what they are worried about is sort of what's going on overall. And so they have special measures that are designed to filter out sort of the month-to-month noise and just look at the inflation that covers the entire economy. So that's what core inflation is. And again, the measures are a little hard to sort of describe, but they have complicated models that can do this. And according to their models, we're still running sort of three and a half percent. So it's still significantly above where they want to be. What are the sticky things when it comes to inflation then? Like what are we

keeping an eye on, I guess, for 2024 of those things that are really hard to bring down? Well, the one really big problem is housing costs. And some of those have been because the Bank of Canada did increase interest rates. Obviously, that increased substantially the cost of mortgages. And it also, by extension, it's increased costs for anybody building homes, anybody renting homes. But some of those costs are not necessarily just from interest rates. Increasingly, the shortage of housing supply in the country has become an issue in terms of pressuring those costs. Right. That's not going to be fixed anytime soon. Even when interest rates start to come down, we'll still have this housing supply problem that will still keep upward pressure on a lot of housing costs, not just mortgages, but rents and other things. So that's one that is almost certainly going to stay sticky.

It doesn't necessarily mean we can't get down to 2%, but it's going to be offsetting some other things that are coming down more quickly. Food prices have been sticky. They're still too high, but they have been coming down pretty quickly over the past few months. And it looks like that trend is likely to continue. Remember, of course, we look at year over year prices.

So we're still comparing things to what they look like, you know, 12 months ago. Like last January. Yeah, that starts to look, as those pressures come off, those year-to-year comparisons start to look better. And that's been happening with food prices. They're still a little warmer than the central bank would like, or that really any of us would like, but it looks like they are coming back under control. There's a lot of service industry prices that have remained hotter than goods producing prices. Some services such as like restaurants, hotels, things like that, they were a lot slower to come back in the recovery, but their prices have remained hotter.

People seem to continue to be consuming those more than they are in some of the goods areas because they're a lot less sensitive to the increase in interest rates. So those are still running hotter. They have proven a little stickier. We're not entirely sure what is going to cause them to start to soften, but presumably high interest rates for longer are going to do the trick, which is what the central bank is still kind of waiting to see. Okay. So let's talk about interest rates then, because this is really key when we're talking about inflation. So the Bank of Canada raised its key interest rate four times in 2023. But since last June, the interest rate has held steady at 5%. So Dave, what are economists saying the trend will be for 2024? The financial markets have sort of based on the

way they are pricing some of the products in the markets that work as proxies to the bank's policy rate, those products are showing cuts as soon as the spring, sort of March or April. Probably April, unlikely it would happen as soon as March. Sorry, can you explain that? What do you mean? Yeah, there are products in the bond market that essentially mimic the Bank of Canada's short-term interest rate, which is what they call their policy rate. It's the target for the overnight rate. It's what they lend money to banks at. So there are products in the markets called swaps, and they imitate that. And so you can kind of look at them and look at what people are paying for swaps that expire months from now.

And you can see what that implies for where they think that interest rate will be. And again, the prices on those right now suggest the first cut could be April. Most economists don't agree with the market. They think the market is getting ahead of itself. They think June or July is probably more likely for the first cut. So somewhere like mid-year, basically. Yeah, I think mid-year is probably a decent guess. A lot will, again, depend on what those core inflation indicators are showing the central bank. If it feels

comfortable that things are heading in the right direction, it is said repeatedly, and it's absolutely true, it doesn't actually need to get to its 2% target before it starts cutting. It just needs to see into the future and see that everything is on track to get there. And how much could we see those rates go down? Very good question. And the answer is, I don't think anybody knows. You can sort of do the arithmetic and say, oh, if we start cutting in the middle of the year, if that leaves four or five rate decisions for the rest of the year and the bank wants to cut a quarter of a percentage point each one, that puts you at sort of 4% or three and three quarters down from the current five. But that's sort of counting it on your fingers. Is that the way the bank's going to do it? Will it maybe move faster if it thinks that the economy is running too slow and it needs to take

the pressure of interest rates off it more quickly? That's possible. If it's uncertain that inflation is really on target, might it sort of move more slowly and sort of do a wait and see, do little cuts, spread out a little bit more and see what the effects are, that could happen too. So I think most economists think we'll be under 4% by the end of the year. Some think we could be below three and a half. It's interesting because we've spent the last year or so talking about what happens when interest rates are raised, right? And I think we're all very familiar with that now, but what happens when they're lower, Dave? I mean, I guess just walk me through what we'll start to see.

Well, you can kind of gauge how much pressure interest rates are having on the economy, sort of where they are relative to inflation. Inflation is at 3% heading towards 2%. And as it starts to go lower and the interest rate remains at 5%, it's effectively putting more pressure on the economy because that gap sort of implies how restrictive those rates are relative to the economy's capacity. An interest rate probably around 3% is probably kind of neutral-ish. Obviously, if they lower the rate faster than inflation is declining, and it's entirely possible that they will, then they'll actually be reducing pressure on the economy. They'll actually be not so much stimulating demand, but certainly restricting

demand less than the current rates are now. So we'll start to see a little more economic activity. Obviously, from an individual standpoint, we start to see less pressure on household debts. We see lower interest rates for borrowing, especially for mortgages. Anybody who's got a variable rate mortgage and they've seen their costs go up like crazy as interest rates went up, they'll start to actually see that retreat,

start to get a break in their monthly payments. And that frees up more money to spend see that retreat, start to get a break in their monthly payments. And that frees up more money to spend on other things, which is why it helps stimulate more spending. We'll be back in a moment. Okay, so we've talked about inflation, we've talked about interest rates. The third point that you were mentioning there, Dave, is this recession watch. All of the things that we looked at in the economy over the last few months are still going to be the pressures that we're looking at for the next few months and maybe longer. So it's certainly going to be a key how high interest rates stay and for how long. They will be restricting economic activity throughout the year, they do have a sort of a lagging impact

on the economy. That's well understood about interest rates for a long time. Obviously, if I don't purchase a car, it starts to affect somebody who runs a car dealership, and then they're not purchasing something because their business is slower. And then their employee is the same way. So it sort of works its way through the system. We can expect to see the labor market, which has already been slowing, slow further. It's not done yet. We're probably going to see unemployment rates around 6.5%. Some economists think as high as 7%.

I don't think it'll get to 7%, but it'll probably be in the mid-6s. And so we're in the high 5s now. So it's going to be more. We are seeing businesses actually laying people off. They're not just delaying hiring as they were earlier in the downturn. So we're going to see more of that. We're going to see more slowdowns. And that was something that we talked about before because it was in a way a little bit strange to see unemployment stay so low when all of these other things are going on, right? But you're saying that will creep up.

Yeah, it'll creep up. I don't think it's going to look as bad as it has in many recessions. And it's one of the things that's probably going to, I guess, buffer us from the risk of an outright recession is the fact that the labor market went into this extremely strong with very high demand, with very low unemployment, with a lot of job vacancies. Those job vacancies have pretty much normalized now. And the unemployment rate is something, it's still historically low, but it's not as good as it was. But it's still a pretty strong labor market given how much the economy has already slowed. So even if the labor market weakens a little bit more, it's normally in a recession, you have a lot of job losses, which creates a lot of slowing

of consumer demand, which is what sends you into a contraction of the economy. We might not get that. When it comes to consumer spending, we've talked a little bit about this, but are we going to see spending uptick? Do we know yet? Because if inflation is kind of being brought under control, I would imagine that's kind of the next step. But is that hard to know at this point? It's a bit hard to know. I mean, a big wild card anytime you're looking at where the economy is

going is the psychological one. We don't know the prevailing mood of consumers. To go back to the mood ring, yes. And it does matter. I mean, consumer sentiment, business sentiment, there's a reason why there are monthly surveys that various organizations do on these things because they want to gauge what's sort of in the minds of business owners and consumers. It gives us a very good idea

of what their spending intentions might be. And we really won't know how much effect a slowing of inflation and an easing of interest rates will have until we're kind of there. And again, it's not just throwing on a switch just because these things start to improve doesn't mean that in our heads we feel it yet and that we're comfortable going out and spending again. A big issue will be mortgage resets.

There's a lot of renewals of mortgages that are coming up in the next year. So far, we've only seen about 45% of Canadian mortgage holders actually have increases in their payments as a result of the increases in interest rates. If you took your mortgage out before interest rates started going up, and a lot of people did,

you might not have had any impact from the interest rates yet. But when your current mortgage expires and you need to renew, then you're renewing at a much higher interest rate. We're probably going to have about another 15 to 20% of mortgage holders actually see their mortgage payments increase this year as a result of renewals. And then, you know, probably see something again the same next year. So by the end of 2025, most people who are going to see a hit from interest rates will feel it on their mortgages. But like I said, this takes time. This is part of the reason why there's a lag in the impact

of interest rates, because it doesn't affect all people at the same time. Of course, we've been focusing on Canada here, but we don't exist in a vacuum, right? So what are we seeing more broadly just in the global economy? What's going on there? Yeah, that's the thing is we often get focused, get the blinders on a bit on what's happening in our own market. But this is pretty much what every industrialized country is dealing with. The timing and the depth of it is a little bit different, but every country is looking at much

higher interest rates. They're looking at very slow to no growth in the next year. They're looking at increased debt pressures on households. And so, you know, a lot of the strains that we're looking at, they're looking at. And just lastly, Dave, I've got to ask you directly about the potential recession. It seemed to never really materialize, at least in 2023. And there was talk of that elusive soft landing, right, where we could maybe bring down inflation by increasing interest rates without actually triggering a full recession. Is it possible that we've achieved that soft landing? Well, I've been doing this for a few decades now. And any time there was a great deal of talk about soft landing, I had learned that that probably meant that we had already failed to achieve a

soft landing. This one is weird. This is the one time, I hate to say this time is different, but this time feels different. And it's really because those employment markets, those labor markets were so strong going into all of this that they created a buffer to the kind of downturn we would often have that would send us into a full-out recession. And they're still relatively healthy, even though they're weaker than they were. But we're talking about growth of under 1% in GDP for the full year.

And we're talking about that not just in Canada, but in most industrialized countries. Technically, a recession is two quarters of negative growth. Yeah, people talk about that as a technical recession. It's not a very good definition of a recession. Really a recession is sort of a sustained decline across a broad range of the economy lasts more than a quarter or two. So, I mean, that's sort of where the two quarters come from,

but it's not really all that you need. I mean, you generally need not just a contraction in growth, but you also need losses in jobs. You need sort of broader pain to be visible throughout the economy. And we're seeing some of that, but not all of that. And we're at a point where really, if anything really bad happens to the global economy, it could push us over the edge and actually create the conditions for a genuine recession.

So we're still on the lookout for that then. It's still a potential in 2024. Yeah, we'll keep on watching it and we'll keep on talking about soft landings. And then in general, we figure it out when it's already in the rear view mirror. We look back and we look at all the indicators and say, did we make it? Did we land softly or was there a little bit of a bounce there? But the conditions are pretty fragile. Dave, thank you so much for taking the time to go through this. Oh, it's my pleasure. That's it for today. I'm Maina Karaman-Wells. Our producers are Madeline White, Cheryl Sutherland, and Rachel Levy-McLaughlin. David Crosby edits the show. Adrian Chung is our senior producer, and Angela Pachenza is our executive editor. Thanks so much for listening, and I'll talk to you tomorrow.