September 29, 2023 | 12:29
Mapping Canada’s Economic Conditions
Mapping Canada’s Economic Conditions
The Canadian economy is struggling under the weight of inflation and higher interest rates, with growth expected to stagnate into 2024. While the Bank of Canada could be done raising rates, past increases will continue to weigh, and consumer spending is expected to weaken as households adjust to rising mortgage costs. Business investment is choppy, while government stimulus is adding modestly to growth. Even the very tight job market has softened, a theme that should continue into next year.
All provinces are grappling with these macro factors, but some will hold up better than others (Chart 1). Alberta and Saskatchewan are expected to lead the country this year with real GDP at 1.7% and 1.3%, respectively, and Alberta should remain atop the pack in 2024 at 1.2%. Demographic inflows and still-high oil prices are helping. Alberta has barely seen a real estate downturn, while Saskatchewan is seeing major resource-sector project build-out. Manitoba remains steady, with growth expected roughly in line with the national average this year and next.
Meantime, the real estate downturn is playing a significant role in British Columbia and Ontario, as they perform at or below the national average this year. In B.C., residential investment carries the highest weight in real GDP in the country. While that share is proportionally lower in Ontario, the downturn there was the sharpest in the country, and the spillover into discretionary spending will likely be meaningful, although torrid population flows are masking this somewhat in the aggregate. Counter to an aggressive push by policymakers, new housing construction in these provinces could dip this year and next, depending how market conditions evolve. Quebec also faces the broader impact of high rates and slowing U.S. demand, although the softer loonie is acting as a buffer for exports and manufacturing.
Atlantic Canada continues to grow faster than recent years, as the region is drawing in strong population flows from outside the country and other provinces. While a slowdown is likely, growth prints should remain positive and above the national average through 2024 as consumer spending and residential investment remain sturdy.
Inflation Still Grips the Nation
Inflation remains a challenge from coast to coast and, while the degrees have varied slightly, a key takeaway from this episode is that all provinces have faced a significant inflation shock. Canadian inflation now sits at 4.0% y/y, down from the 8.1% y/y high in June 2022, but 1.2 ppts above the recent low set in June 2023. The move up in oil prices has complicated the inflation picture, with all provinces seeing an acceleration in price pressure in recent months. Here are a few notable current trends:
Inflation remains well above the Bank of Canada’s 2% target across all provinces (Table 1). All provinces are seeing inflation rates in excess of 3% y/y as of August (four are north of 4% y/y), and core inflation trends are similarly sticky.
Cost-of-living pressures are highlighted by strong inflation rates in food and housing. Nowhere in Canada is food inflation lower than 6% y/y, with a weak loonie, high transportation costs and firm wage pressure acting similarly across provinces.
While resale real estate prices corrected, rents continue to run at a strong pace. Some areas where the population boom has been more acute—such as Ontario and Atlantic Canada—are seeing stronger gains, but nowhere in Canada is there much relief.
The better news is that goods price inflation has cooled, for the most part, across the country. Inflation in clothing, household operations and recreation/education is running below the Bank of Canada’s target in most jurisdictions.
Housing: Eye of the Correction?
Canadian housing activity is winding down a sluggish summer, with sales and prices losing momentum after the Bank of Canada resumed its rate-hike campaign before pausing again on September 6th. While we wouldn’t fully write off this market given underlying demographic demand, there are a few reasons why it might struggle into 2024. Softer job-market conditions could ease demand, and more listing availability should weigh on price growth. Most importantly, mortgage rates keep pushing higher. In the spring, both two and five-year GoC yields were down more than 60 bps from the start of the year by March, which translated into some fixed mortgage rates falling comfortably below 5%. Now, deepening bond-market selloffs have 5-year GoC yields pushing 16-year highs. That leaves the lowest available mortgage rate today more than 100 bps higher than the lowest that was available in the spring.
Looking across the country, we’re now seeing some clear regional discrepancies in housing market performance. Calgary remains the strongest market in Canada, and it’s not really close (Chart 2). The sales-to-new listings ratio there is running at a hot 82.4%, and prices have now rebounded more than 6% above the 2022 pre-correction high (Calgary’s correction was also among the most modest in the country). At the same time, prices in Atlantic Canada are looking firm, with a few markets now seeing levels above those at the 2022 high. What do these regions have in common? Relative affordability and net provincial migration inflows that are supplementing international immigration. Translation: People are moving there because they can live affordably.
At the other end of the spectrum, Southwestern Ontario continues to struggle with the deepest correction, still down more than 15% in some cities. Toronto has made up some ground recently, now down less than 10% from last February. Cottage country is not looking good.
Meantime, households will continue to adjust to steady waves of mortgage resets through 2026. The 2024 vintage could see payment increases in the 25%-to-40% range if current interest rates hold, with the increases becoming even larger in 2025 and 2026 (although we assume rates will back off by then). This suggests that discretionary household spending will face a steady headwind.
At the provincial level, British Columbia and Ontario look to be most exposed to any further real estate downturn and potential mortgage-market driven economic weakness. Both provinces carry above-average household leverage and exposure to real estate, while Ontario was unquestionably the frothiest market during the boom (Table 2). British Columbia’s household debt-to-disposable income ratio is the highest in Canada at just under 220%, while Ontario is second at 206% (compared to the 164% provincial median). In both provinces, real estate and mortgage debt make a disproportionately large share of total household assets compared to other provinces. At the other end of the spectrum, Quebec and Atlantic Canada carry relatively low exposure by these measures (some of it is just demographics as these populations are older). And, while Alberta carries above-median readings, market conditions in that province also suggest much less risk.
It has been a quiet summer for budget outlooks among the provinces; and, as the fall fiscal update season approaches, look for relatively steady forecasts. That’s good news given the solid current position for the group, but will also be a noticeable change compared to the past two years, when fiscal projections consistently and meaningfully outperformed. Indeed, some of the most recent Q1 updates/public accounts have hinted that there might be some downside to revenues versus what most projected in the spring.
The combined provincial budget deficit is currently estimated at a modest $7.0 billion for FY23/24, or 0.2% of GDP (Table 3 and Chart 3). While that marks a deterioration from two consecutive surpluses averaging roughly $10 billion in the two prior fiscal years, the key takeaway is that the books are largely in balance. The combined provincial net debt-to-GDP ratio is pegged at 29% for FY23/24, which is 1.5 ppts below pre-COVID levels. At the same time, the provincial ratio is running 14.5 ppts below the federal debt ratio, given that the latter swallowed the vast majority of COVID-related support spending and borrowing. This is a solid starting point if we are heading into choppier economic waters.
For oil-producing provinces, recent trends in global prices are again supporting revenue potential. In Alberta, for example, the FY23/24 budget was based on $79 WTI, and recent price moves have erased any downside risk that had built up into early summer.
This fiscal year, the provinces look to borrow $97 billion, up from last year’s total, and somewhat above the typical pre-pandemic pace—maturities and some heavy capital-spending programs account for this, despite near-balanced budgets. As of early September, just under half of the borrowing program was completed.