Thoughts

September 29, 2023 | 12:59

Sink or Swim for the Canadian Economy

Economist

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

The struggle is starting to look real in the Canadian economy, and the headwinds might only be getting stiffer. Canadian real GDP was flat in July, and a modest +0.1% initial read on August leaves growth for Q3 barely in positive territory. Over the past six months, real GDP is effectively unchanged, which starts to look pretty rough when considering that the population is exploding at a 3% per-year run rate. While we’d love to insert some rays of optimism here, the challenge is that the recent action in the bond market is not cooperating, pushing borrowing rates even higher, and the typical 12-to-18 months lags in monetary policy suggest that the most aggressive phase of the tightening cycle (last summer) is about to fully bite. As such, we continue to forecast very little real growth between now and next spring.

There were even signs that Canada’s rock-solid labour market is softening this week, although from extremely tight levels. While the payrolls report is a bit of old news (the latest release covers July), it provides important details on employment, job vacancies and wages. Employment continues to run at a solid pace, up 2.5% y/y, but job vacancies are now plunging, down 5.8% in July alone (-43k) and 28% in the past year (-274k). (Recall that Canada had more than 1 million job vacancies at the peak in early 2022, or effectively one job opening for every unemployed person.) That leaves the job vacancy rate at 3.9% compared to the 5.7% high set last spring. While that’s still above pre-pandemic levels in the low-3% range, the excess demand is fading fast. Still, there’s little evidence that wage growth is cooling, but wages are a slow-moving train that take time to change direction once they get going. Think of the ongoing negotiations and work stoppages now as contracts come to renewal, following three years of inflation and job market tightness that didn’t exist when those were initially inked. That said, given plunging vacancies and an unemployment rate that, while still low at 5.5%, is up 0.6 ppts from the cycle low, wage pressure should ease through 2024.

Masking all of this is the fact that Canada’s population surged by almost 1.2 million people in the year through July 1^st, by far the largest absolute increase on record. In percentage terms, the 3.0% y/y gain matches the largest yearly increase since the 1950s post-war boom. It’s very hard to bring down an economy in the aggregate when the size of the population is growing this quickly. But at the individual or household level, things appear to be getting tougher. In per capita terms, Canada’s real GDP is now on track to be down more than 2% y/y in Q3, a magnitude of decline typically only seen during recession—the difference this time is that it’s the denominator that is surging. Since the end of 2016, Canada’s real per capita output is now little changed compared to sturdy 1.7% annualized growth in the U.S. Clearly there are longer-term demographic benefits from robust immigration, especially if those flows are concentrated in much-needed skilled areas of the job market. But the rate of flow matters given that the supply of housing, health care services and other necessary infrastructure can’t possibly respond fast enough to the current pace. That, combined with the fact that more than half of net inflows over the past year (a massive 700k people) were nonpermanent residents (a large portion international students), suggests that the current calibration leaves the near-term balance of the population boom in inflationary territory, before we eventually see the longer-term disinflationary impact.

For the Bank of Canada, it’s complicated. This remains a tough spot where any signs of slowing are being countered by the inflationary impulse of torrid population growth, still-stubborn core metrics, and lags between turning points in the job market and wage growth. It all suggests that the Bank will keep leaning on the economy and inflation with the tightening that has already been put in place, while downside pressures continue to build.