Canadian Quarterly Economic Forecast

Global

• Compared to our June forecast, we have marked down global growth 0.1 percentage points, taking it to 2.8% in 2022 (from 2.9% previously). The outlook for 2023 has deteriorated substantially, with growth expected to advance 2.2% – down from 2.7% in June. 
• The deepening energy crisis in Europe is expected to buckle the economy as the year progresses. Limited natural gas supplies reflects a supply-side shock that ultimately reduces the productive capacity of the economy. Establishing new energy supply lines will take time. In the interim, some firms will be unable to operate, and others will face higher energy input costs that compress margins. Given the backdrop, ongoing fiscal support for worker retention schemes and to offset rising gas costs will be critical to mitigating the reduction in labor demand, but is unlikely to prevent it. 
• In China, below-trend growth is set to continue through 2023 as depressed consumer confidence and the sagging real estate market weigh on output. Moreover, soft export growth amid weaker demand from advanced economies will offset the competitive benefits of a weaker renminbi. That said, a policy pivot could counter the decidedly gloomy outlook. For instance, further relaxation of COVID containment policies and additional support for the real estate market can help to restore consumer confidence, but we’re not overly confident that the government will embrace that pivot. If it does, it would help lay the foundation for a stronger bounce-back in 2023.

United States 

• U.S. economic growth disappointed through the first half of the year, with the average of Q1/Q2 growth contracting by 1.1%. This outcome was at odds with other measures of economic activity – such as gross domestic income – that showed an expanding U.S. economy over the same period. Neither measure is perfect, and the reality likely lies somewhere in the middle. Either way, the slowdown in domestic demand has not been sufficient to take the heat off inflation, which continues to surprise to the upside. This has led us to expect a more aggressive path for monetary tightening through the remainder of this year. Likewise, we have revised down our economic growth forecast for 2022 to 1.6% (from 2.2%) and 2023 to 0.7% (from 1.4%).  
• The U.S. consumer has shown a degree of resilience in the face of rising inflation and higher interest rates. Consumer spending growth has hovered around a trend pace (1.9%) through the first half of 2022. If a soft landing is achievable, consumers hold the lynchpin. Our near-term tracking suggests spending will hold somewhere in the 1%-1.5% range through the second half of 2022, before slowing to a 1% pace in 2023 as household’s are further squeezed by higher rates and weaker employment growth. However, excess savings and student debt relief (which has not been incorporated into the forecast) offer some upside.  
• The pace of job growth has defied gravity through 2022, and various indicators point to continued momentum over the near term. However, the labor market will not remain immune to the Fed’s rapid rate hike cycle. Job growth is expected to cool through 2023, putting upward pressure on the unemployment rate. We expect the unemployment rate to rise by 150 bps – peaking at 5.1% by the end of 2024.  
• Inflation is showing more persistence across both goods and service categories. This has led to an upward revision to the near-term inflation outlook and more persistence. Core PCE inflation is still expected to cool over the next year in response to weakening demand – reaching 2.7% y/y by the end of 2023 – but it will still be sitting above the central bank’s target. The move back to 2% will prove to be far slower, with core PCE not expected to reach 2% until early-2025.      

Canada 

• The Canadian economy grew at a 3.3% pace over the second quarter of 2022, making it a standout performer on the global stage. Since public health restrictions were lifted earlier this year, mobility has increased, propelling spending, corporate profits, and nominal incomes. Elevated commodity prices are also providing a fillip to Canada’s expansion rate this year. A strong first half will boost annual average GDP growth to over 3% in 2022, before decelerating to approximately 1% in 2023. 
• We expect to see a further rotation away from durable goods spending towards services through Q3-22, as pent-up demand for recreation and entertainment are unleashed. However, the impact of higher interest rates and elevated inflation will increasingly leave its mark on overall spending activity in late 2022 and into 2023.   
• Given the expected slowing in demand, the underlying economic dynamics won’t be sufficient to generate enough jobs to absorb people entering the labour force or those already on the sidelines. This means the unemployment rate should push higher. It has already risen from a low of 4.9% to 5.4% and is expected to reach 6.5% in 2024.  
• The impact of higher mortgage rates will continue to depress residential investment through 2023. Prospects for non-residential investment are brighter, supported in part by strength in commodity industries and development of long-term resource projects.     
• The inflation outlook for this year has been upgraded since the June forecast, with little relief expected in the second half of this year. In 2023, CPI inflation is forecast to return to a more palatable level with the help of easing supply chain disruptions, lower energy prices and under more stagnant economic growth. All told, headline and core CPI are expected to reach 2.6% year-on-year by the end of 2023.     

Financial 

• Excess demand and multi-decade high inflation have central banks determined to lift rates further into restrictive territory. We expect the Federal Reserve and the Bank of Canada to hike their policy rates to 4% by the end of 2022. Both short-term and long-term yields will rise over the coming months on the back of higher policy rates and higher term premiums, with 10-year yields expected to eclipse 3.6%.   
• The Canadian dollar may see some appreciation versus the U.S. dollar over the coming months if the risk-off move in financial markets eases, and the Canadian economy can maintain its outperformance on the GDP front. The euro and pound will be dependent on the geopolitical environment and these currencies appear to have some further downside in store given the threat to natural gas supply over the coming winter. We are pessimistic on EM currencies relative to the USD, given weakness in their respective economic recoveries.