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November 01, 2024 | 13:37
What Canada’s Immigration Shift Will and Will Not Do
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
What Canada’s Immigration Shift Will and Will Not Do |
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Ottawa’s dramatic about-turn on immigration will turn Canada’s fiery 3%+ population growth of the past two years to an icy near-zero pace in coming years. This may have some important economic effects, but there are already many misleading narratives that have emerged since the announcement. Operating under the assumption that most of the new targets are met in the 2025-27 period, here are some areas we believe will be affected by the big shift, and those that will not. |
Economic growth will be affected, but probably not nearly as much as widely predicted. Basic arithmetic suggests markedly slower labour force growth and fewer potential new consumers should cool demand and spending. But what will not happen is a recession or a steep slowdown as a direct result of these policy changes. After all, if population growth is such a direct driver of economic growth, how did Canada just see the former balloon by 6% in the past eight quarters, while real GDP only managed to eke out a mere 2% advance over the same period? The reality is that the propensity to consume and average income is lower than the general population among new arrivals, and growth will not be affected one-for-one. Indeed, the history of the past 50 years shows zero direct link between short-term trends in growth and population (Chart 1). The fact is that the other 97% of the population will be driven by typical underlying factors such as interest rates and fiscal policy changes, and their own income growth. Having said that, there may be some downside bias to our call of 1.8% real GDP growth in 2025, and 2% in 2026. The heavy-duty offset to any softening in overall growth, of course, is that GDP per capita is poised to strengthen meaningfully after a few very rough years. Given all the various forces at play and looming uncertainties—not the least of which is the U.S. elections—we are not yet prepared to adjust the call. Inflation will be clipped slightly, but it will not be materially affected. The Bank of Canada’s longstanding view is that population growth is on net neutral for inflation, as the demand factors are outweighed by supply forces. We would mildly quibble with that contention, as cross-country evidence suggests that there is a slight positive relationship over time between population and inflation, mostly driven by the shelter component (i.e., stronger population growth leads to faster home price inflation; Chart 2). As we delve into below, the immediate impact of much slower inflows will be on rent inflation, with some secondary dampening of broader consumer spending and inflation. The potential supply side effects, of slower labour force growth and possibly a tighter job market, will take longer to unfold. Again, we are not yet trimming our near-term inflation call, given all the other variables at play—including the recent big swings in energy prices—but would note that the risks appear to be to the downside for our call of average CPI inflation of 1.8% next year and 2% in 2026. |
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Rent growth will be dampened relatively quickly, with outright declines in some markets. It’s no coincidence that rent growth began to accelerate shortly after permanent immigration targets started rising steadily in 2016. And, it’s no coincidence that rents exploded alongside the more recent surge in nonpermanent resident inflows (Chart 3). Given how quickly demand conditions can change, but how long it takes for supply to adjust, this is arguably the area where outsized population growth has the biggest impact. Nonpermanent residents (and newcomers more broadly) are typically renters first, and we would therefore expect an immediate flattening of demand growth. At the same time, a full pipeline of supply—be it investor-owned condos or purpose-built rentals—is coming to completion in major markets like Toronto and Vancouver. Note that, as of September, growth in average asking rent across Canada has already slowed to just 2% y/y according to Rentals.ca, with outright declines seen in some markets—more weakness is likely incoming. |
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The home price impact is more nuanced. The market for family-oriented single-detached housing remains relatively tight, especially in the larger cities, and is supported by demand from younger domestic families as well as past newcomers looking to trade up. Prices in that segment in markets like Toronto, Vancouver and Montreal should hold up relatively well, even if they remain challenged in some exurban areas that were subject to more froth. Urban condo prices, however, will be in tough given that investors made up an increasing share of incremental buyers, and unit sizes have been steadily falling. When investors had low borrowing costs, expectations of price growth and strong rent/growth expectations, the calculus made sense. Now, however, none of those conditions exist and major-city condo prices are likely headed lower still. Ultimately, the backdrop of falling mortgage rates and easing mortgage rules has a bigger impact on resale home prices, but this change will, all else equal, dampen home price growth and make the journey back up to early-2022 price levels longer. Homebuilding activity will fall in some markets, but the downside for Canada overall will be limited by past excess demand. Household formation averaged roughly 190k per year in the five years through 2019, and a steady state of around 200k would be consistent with population growth around 1%. In the meantime, formation could fall sharply over the next three years. With robust completions coming online, this will narrow the housing demand-supply gap—Ottawa estimated a 670k unit reduction in the gap by 2027. Indeed, it has long been our view that this misalignment in Canadian housing availability was largely a demand-side issue, and this measure will move to narrow that gap much quicker than various supply-side measures. That said, Canada still has a large cohort of millennials looking for suitable housing, and there will likely be some unbundling of households as the supply-demand balance eases. That should limit the downside for starts. Still, there are pockets of weakness, such as the privately-owned condo market in Toronto, that will pull down activity in the next few years given current market conditions. We see 235k housing starts in 2025, down from 245k in 2024, with a gradual drift toward 200k as the imbalance gets worked out. |
The unemployment rate has risen by 1.7 ppts from its 2022 low amid a 6% surge in the labour force since then and a moderation in job growth. Note that Canadian job growth has kept pace with the U.S. over the past year, but the jobless rate has risen much more quickly in Canada due to rapid population growth. Labour force growth may well stall in the next two years, leaving employers seeking to fill positions from those already looking for work. As a result, we expect the unemployment rate to soon top out at just above 7% and then gradually fall over the next two years. But what will not happen is severe economy-wide labour shortages. While some sectors will be challenged, the reality is that there are now more than 1.4 million unemployed Canadians—a level only previously surpassed in the wake of recessions—and just 500,000 vacant jobs (Chart 4). That ratio of 2.8:1 signals a loose job market, and is miles away from the 1:1 in mid-2022 at the peak tightness in the job market. |
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Wage growth could remain firmer than normal against this labour market backdrop. Much less competition for entry-level positions means the demand/supply balance will shift back to workers. But even for higher-paying positions, the balance may also tilt given that more of the permanent resident positions will be absorbed by those already in Canada. This will come at a time when wage growth is already quite firm, and had been one of the few remaining brakes on an easier Bank of Canada policy stance. The latest MPR noted that one upside risk to the inflation outlook is that “wage growth could remain high relative to productivity”. The offsetting news is that productivity growth could see a moderate bump in the next few years. Again, this is mostly a matter of basic arithmetic, as the input of labour could slow notably even as the capital stock trend is largely maintained. At least part of the explanation for the outright decline in Canadian productivity over the past five years is that the surge in relatively low-skill employment heavily shifted the capital-labour balance, undercutting output per hour. However, it’s highly doubtful that a two-year hiatus in population growth will do much to affect Canada’s decades-long sluggish productivity performance. How do these many cross currents affect the interest rate outlook? The combination of somewhat milder potential GDP growth, slightly less near-term pressure on inflation, and less danger of froth building in the housing market, could ultimately lead the Bank of Canada to trim even more than we had initially expected. However, we suspect that the immigration adjustments won’t have much impact on near-term policy decisions—the Bank will be responding to the data on the ground, and it will take time for the shift to make a mark. But where it could have an effect is on how low the Bank eventually does take its overnight rate. We suspect that slightly lower potential growth will prompt the Bank to shave its view on neutral interest rates—perhaps clipping them by 25 bps from the current estimate of 2.25%-to-3.25%. And given potentially cooler actual spending growth and inflation, it may be willing to go to the very low end of neutral as a terminal rate—i.e., eventually taking the overnight rate from 3.75% now to 2.0% by late next year (our current terminal assumption is 2.5%). The Canadian dollar is largely an afterthought in this discussion. Yet, weaving through the logic of the growth, inflation and interest rate outlook, the policy shift could on balance weigh further on the near-term outlook for the currency. Ultimately, a potentially lower neutral interest rate and a possibly more dovish BoC could keep Canada-US rate spreads wider for longer, tugging further on the loonie. The currency is already probing lows rarely seen in the past 20 years, and may well remain under pressure through 2025, particularly as we head into the review of the USMCA in the following year. |
Bottom Line: The abrupt shift in Canada’s immigration policy does carry a variety of important implications, and we have only addressed the economic aspects—there are also the impacts on infrastructure, social services and health care availability. But our core message is that while this is an important shift, one shouldn’t lose sight of the bigger picture. Even with Ottawa’s projections over the next few years, this will still leave the five-year trend population growth well above 1%, in line with the prior 20 years, and likely to be close to the target growth in the coming decade. This latest move should be seen simply as a short-term corrective step to adjust for the outsized growth of the past two years and not a fundamental change to the longer term outlook. |
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