October 05, 2022 | 12:36
Cold in the Forecast
The Canadian economy is slowing, and conditions have set the stage for a more pronounced downturn into 2023. Stubborn inflation readings will force further tightening by the Bank of Canada through the remainder of 2022, and the combination will likely dent consumer spending, housing and business confidence. Real GDP growth is expected to slow to zero in 2023 after 3.2% growth this year, with risk of a downturn most acute around the turn of the year.
Growth prospects are also weakening across the provincial landscape, with a number of regions at risk of recession around the turn of the year. Negative prints are likely in British Columbia, Ontario and Quebec in 2023, with the real estate downturn playing a significant role. In British Columbia, residential investment carries the highest weight in real GDP in the country. While that is proportionally lower in Ontario, the downturn in real estate there will be the sharpest in the country, a theme already playing out on the ground. While weakness has already flowed through resale activity and prices, slower new construction and renovation activity don’t look far behind. Quebec faces a more modest slowdown in residential investment, but the broader impact of high oil prices and slowing U.S. demand will hit Central Canada relatively hard as well. The softer loonie is acting as a buffer for exports and manufacturing.
At the other end of the spectrum, some provinces could see resilience through the downturn. Alberta and Saskatchewan should face much less downside in residential investment, partly because those markets had already slumped for a number of years before the pandemic boom, and therefore never accumulated much froth. Oil prices, while well off their highs, continue to support local activity, incomes and government revenues. Growth will likely slow in the region but remain in the low-1% range and outperform the national average. Atlantic Canada continues to draw in strong population flows from outside the country and from other provinces. While we see a meaningful slowdown there as well, growth prints should remain positive in 2023. Economic losses and rebuilding efforts post-Fiona will also shape the growth pattern.
Real Estate Correction Underway
Canadian home prices were down almost 8% from the February 2022 high as of August, based on the national MLS Home Price Index. A price correction in Canadian housing is well underway, and many local markets are easily already down 20%. We expect the adjustment to run through most of 2023, as the market absorbs the sharp increase in borrowing costs, while a broader economic slowdown also weighs on previously raging demand.
Housing exposure: British Columbia tops the provincial list with residential investment weighing in at 9.5% of real GDP in the three years through 2020 (latest period with a full breakdown for all provinces). 'Investment' includes new building construction, renovations and resale transactions. All three aspects will be under pressure next year, with the latter down significantly. Ontario and Quebec are a few steps back, at just over 7% of GDP before the pandemic. For some context (given Ontario and Quebec produce quarterly accounts), Ontario's share jumped to 8.7% in 2021 (or 9.4% at the quarterly high); and Quebec rose to 8.2% last year (8.5% at the high). At the low end, Alberta and Saskatchewan have housing weights at less than 5% of GDP. These markets were in prolonged periods of retrenchment before the recent boom, dating back to 2014, so housing's weight is relatively low.
Downside risk by region: Real home prices have historically risen about 3% per year since the early 1980s, roughly reflecting real wage growth and falling interest rates. In the latest run-up, real prices surged by more than a third in the span of two years, stretching well beyond that long-run baseline growth trend. When the market peaked in Q1, real home prices sat 38% above trend, the widest deviation in the past 40 years.
By this measure, the most froth accumulated in the suburbs and exurbs of Toronto. While Toronto prices were 41% above trend, exurbs (using markets 1-2 hours outside Toronto) were ahead by more than 70%. Some regions, however, hardly looked frothy at all. Alberta is a good example where, after five years of declining prices leading into COVID, the market is still just catching up to its long-term baseline. Other markets, such as Vancouver, Montreal and Atlantic Canada were frothy, but not to the extent of Southern Ontario. In all cases, the reversion back to (or perhaps below) baseline is now well underway.
Fiscal Revisions Strong, For Now
Provincial public accounts for FY21/22 and fiscal updates for FY22/23 are rolling in, and they've been coming in strong almost across the board. But, there is downside risk to the economic outlook in 2023 relative to fiscal plans.
The combined provincial budget balance registered a $9.2 billion surplus in FY21/22, compared to a massive $76 billion deficit originally expected during the 2021 budget season. With a few public accounts still pending, six of ten provinces were in the black. Stronger-than-expected revenues were the biggest driver, helped by faster economic recoveries and high inflation.
That strength is also carrying into the current fiscal year, with the combined FY22/23 deficit now estimated at a small $3.2 billion (pending an update from Ontario, which could easily swing the collective balance into surplus). With the exception of Nova Scotia (very minor downward adjustment), every province to report has done so with an improved budget balance.
That said, downside risks to the growth forecast through 2023 are going to permeate through provincial budget forecasts, with all provinces likely to revise down their 2023 real GDP growth assumptions, if our current outlook is any guide.
The downside ranges from a few ticks in parts of Atlantic Canada, to as much as 3.5 ppts in Ontario. Higher inflation will act as a cushion through nominal GDP, but the combination of higher interest rates and wider provincial spreads will also add to expenses. The main takeaway is that most provinces, while now seeing upside to their FY22/23 results, could see that momentum fizzle as 2023 growth forecasts begin to get revised down.
Total provincial borrowing this fiscal year is estimated at $88.9 billion. That will be down from the pandemic peak of around $150 bln, and from last year ($96 billion). Still, the provinces are somewhat more active than pre-COVID, when the run rate was around $80 bln. To date, just under half of the combined FY22/23 borrowing program has been completed.
The B.C. economy is expected to grow 3.0% this year, slightly below the national average, but a dip into negative territory is likely in 2023. The weakness follows a strong outperformance coming out of worst of the pandemic in 2021, when the province grew by more than 6%. While tourism and service activity are now helping the expansion, housing will be a heavy drag on growth in the year ahead, given that residential investment makes up the largest share of provincial real GDP in the country.
The housing market has cooled considerably alongside higher mortgage rates, with sales activity plunging through the first half of the year to levels more consistent with pre-pandemic norms. Prices have also pulled back, with the provincial average down 10% from the February high as of August.
The job market remains strong, and the unemployment rate is expected to average 5.0% in 2022, challenging for the lowest level in Canada. Employment was relatively quick to recover pandemic losses compared to provincial peers.
The Province of British Columbia posted a $1.3 billion surplus in FY21/22, and the budget estimate of a $5.5 billion deficit in FY22/23 has swung to a small surplus. B.C. has seen weakening fiscal metrics over the past few budget cycles, but the surge in revenues last fiscal year has helped considerably.
The Alberta economy is expected to outperform the country with 4.3% growth this year, and hold up relatively well as the slowdown grips most of Canada into 2023. High oil prices are supporting local incomes, even if they are well down from early-2022 highs, while production and capital spending in the energy sector look solid.
After slumping through 2020, oil production has returned to, or near, capacity levels that prevailed before the pandemic. Capital spending growth in the industry looks very firm for the year ahead, but the level of spending remains less than half of its 2014 peak. Even if we don’t expect a resurgence in new project investment, cash flow in the sector looks well-supported.
Housing is less susceptible to the correction given that the market was never as extended as those in Ontario and B.C., but a slowdown will still be felt across the industry. Interprovincial migration flows have also turned positive after six years of outflows, which will help cushion the downturn. That said, the commercial real estate backdrop remains tough, with high vacancy rates in the downtown office market persisting.
The job market has tightened dramatically, with the unemployment rate falling below 5% this summer after topping 15% in early 2020. Notably, that has crossed below the national average for the first time since 2015, and we expect that will remain the case through 2023, as labour markets deteriorate more in other regions.
The Province of Alberta revised its FY22/23 fiscal projection, and is now looking for a hefty $13.2 billion surplus (2.9% of GDP), up from $511 million (0.1%) projected in the 2022 budget in February—that will give the government plenty of room to maneuver ahead of next year’s election. While that estimate suddenly looks a bit optimistic (based on $92.50 WTI oil for the fiscal year), the medium-term outlook looks well into surplus at recent levels, and a weaker loonie helps.
The Saskatchewan economy will likely grow a strong 5.5% this year, leading the country after underperforming in seven of the past eight years. The province should hold up relatively well in 2023 thanks to very little housing forth and a sturdy resource economy.
Agriculture is also poised to rebound after very challenging conditions in 2021 cut output. The resource sector has regained strength alongside higher oil and potash prices. Oil production is grinding higher, and incomes will be very well supported. Meantime, potash prices have soared amid geopolitical turmoil, and BHP’s go-ahead of the massive Jansen project will support activity for the next five years until reaching expected production. Indeed, capital spending intentions in the province look strong this year, with the highest overall growth expected since 2010.
The unemployment rate is falling quickly, dipping below 4% for the first time since late 2014 as the job market tightens. Still, the province continues to see net interprovincial outflows to even stronger jurisdictions, and job market momentum should cool in the year ahead.
The Province of Saskatchewan is projecting a $1 billion surplus in FY22/23 (1.1% of GDP), sharply improved from a $463 million deficit estimated in the 2022 budget. The improvement comes on the back of surging resource revenues.
The Manitoba economy is expected to grow 4.0% this year, ahead of the national increase. Challenging crop conditions weighed heavily last year, but those look much improved for 2022. At the same time, Manitoba’s diverse and steady economic base has historically helped the province outperform during periods of national economic weakness—a direction we are likely headed through next year.
The unemployment rate fell to 3.5%, the lowest level in Canada, in July before climbing later in the summer. While the sharp decline was partly due to a drop in participation, employment has pushed to record levels. Still in the 5% range, next year’s average unemployment rate should be among the lowest in Canada.
Housing activity was extremely strong, but has cooled alongside higher mortgage rates. Like the economy more broadly, we expect the downturn to be more moderate in Manitoba given less froth on the way up. For example, Winnipeg’s benchmark price growth peaked at 16% y/y, less than half of that in Toronto.
The Province of Manitoba is estimating a $202 million budget deficit in FY22/23, or a modest 0.2% of GDP. The fiscal situation overall looks solid.
Ontario’s economic growth is expected to slow to 2.9% this year, below the national average as higher interest rates and a housing correction bite hard. The economy is then expected to contract 0.4% in 2023, with challenging conditions expected around the turn of the year.
Housing activity across the province is in recession, with higher mortgage rates chilling demand and buyer psychology. Unit sales have fallen below pre-COVID levels and are now tracking at some of the lowest levels of the past 20 years. Prices are also falling, with some markets roughly 20% off February’s peak level—suburban/exurban single-detached were hit especially hard early on. We’ve maintained all along that the extreme strength was driven by excess demand, the result of too-low interest rates and buyer psychology. With that now unwound, new construction activity should also cool through 2023 with a record number currently under construction, and presale activity faltering.
In the commercial real estate sector, downtown office vacancy rates have eased to below 10%, according to CBRE, from a high of 12.4%. Net absorptions have turned positive, but rent growth remains under pressure. Some other sub-sectors, such as industrial, remain strong, but cap rates are adjusting to higher interest rates.
The job market has been very strong, with employment powering to a record high as of May, before declining through the summer. Service-sector jobs also sit at a record high, despite a still-wide gap in accommodation & food services employment. Finance, professional services and technology-based industries have been hiring at a strong and almost uninterrupted clip through the pandemic, but momentum looks to be fading.
The Province of Ontario posted a $2.1 billion surplus (0.2% of GDP) in the FY21/22 public accounts, much better than the $13.5 billion deficit last expected in the 2022 budget (April 2022). This is a massive revision that resets the fiscal backdrop in Ontario for the current year and beyond, and is the first surplus for the province in 14 years.
The Quebec economy is on track for solid 3.4% growth this year, ahead of the national average. That comes in part thanks to a strong performance around the start of the year, and a less severe early decline in housing activity. That said, the province will likely struggle to grow in 2023, consistent with a broad weakening across the country. We are still optimistic that Quebec will remain a relative economic outperformer over the medium term.
High oil prices have tilted some relative strength back to Western Canada, and Quebec is typically at the losing end of that shift. Still, the current situation should be more muted than, for example, the mid-2010s period of relative softness—the loonie has weakened, which will contain the impact on exports and manufacturing; the local fiscal and employment situations are much better; and outward migration has neutralized.
The housing market has slowed sharply, with existing home sales falling more than 10% y/y, back in line with pre-pandemic activity levels. Prices are also weakening, but markets like Montreal didn’t see the extreme gains that some others did, and started from a more affordable level. Still, a jump in mortgage rates from 1.5% to around 5% is a significant hit to even a less frothy market. Meantime, residential construction remains strong amid healthier demographic flows (especially fewer losses to other regions). Housing starts are expected to cool in 2022, but to a still-robust 63k units. Softer demand will likely pull that down to 51k by 2023.
The Province of Quebec is on track for a $1.8 billion surplus in FY22/23, or a modest 0.3% of GDP, sharply improved from earlier deficit estimates. But, another $6 billion of policy measures in the re-elected CAQ platform will tip Quebec back into deficit.
The New Brunswick economy is expected to grow 1.8% this year, softer than the national average. Keep in mind that the pandemic contraction was also much milder than most other regions, so there has been less ground to make up. Growth should fade below 1% in 2023, but the region should be relatively insulated through the downturn.
The unemployment rate has trended around 7% so far in 2022, which is somewhat below rates seen in the three years before the pandemic. Employment in impacted industries, such as trade and accommodation & food, has fully recovered from the 2020 decline, leaving service-sector jobs above pre-COVID levels. The participation rate, however, continues to drift down as the population ages.
That said, population growth has surged to near 2% y/y, the fastest pace since the mid-1970s, led by a rebound in international immigration and a surge in interprovincial migrants. The latter has come as families look for space and affordability in a new hybrid/remote-work environment. The consequence has been some stress on living costs.
The Province of New Brunswick’s $777 million FY21/22 surplus will narrow to $136 million in FY22/23. Small surpluses persist through FY24/25, highlighting the strong turnaround in the Province's fiscal situation.
The Nova Scotia economy is expected to grow 1.6% this year, cooling from a strong 5.8% surge last year, with the impact of Hurricane Fiona weighing, but still uncertain. Demographic strength and a rebound in tourism have powered well above-potential growth in the near term, but a slowing is imminent, and we see 1.0% growth in 2023—that should still outperform the national average.
By mid-year, international travel flows into Canada were up sharply from the pandemic lows, but still running at only 60% of 2019 levels. With border restrictions eased, summer 2022 was likely a better season for travel activity.
The job market is also strong. The unemployment rate has trended just above 6% in recent months, as employment continues to rise. Full-time employment has surged, while part-time jobs have been more volatile alongside choppy hotel & restaurant hiring—but they too are back to pre-COVID levels. Labour force participation is still somewhat restrained. There are early signs, however, that job market momentum is cooling.
Resale housing market activity has cooled sharply, with sales well down from extreme early-2021 highs, while prices peaked in April. Interprovincial migration flows are running at a record-high 11k per year pace. As a result, building activity remains robust and, while cooling, should lead to 6,000 housing starts next year.
The Province of Nova Scotia is estimating a $554 million deficit for FY22/23, or 1% of GDP. Shortfalls are expected to persist over the next four fiscal years, while the net debt burden gradually rises.
Prince Edward Island
The PEI economy will likely expand 1.5% this year, weighed down by the impact of Hurricane Fiona. Rebuilding efforts should boost activity next year and, while the impact is still uncertain, we're looking for 1.3% growth. Recall that the province was enjoying a significant boom before the pandemic, and also led the country with 6.6% growth in 2021. There are signs of strength continuing, including demographic flows and a return of tourism activity.
Tourism and seasonal visitors during the summer months are major drivers of local economic activity, and both of those sources have improved. With Atlantic and Canadian travel opened back up, U.S. and Canadian inbound travel should be winding down its strongest summer since the pandemic began. Meantime, an influx of migrants, both from abroad and from other parts of Canada, will continue to support robust housing demand, even as higher interest rates cool prices.
The unemployment rate fell below 5%, a record low, at one point in June before ticking back up. Employment has surged, including among full-time workers, but labour force participation hasn’t yet returned to pre-COVID levels.
The Province of Prince Edward Island is projecting a $93 million budget deficit for FY22/23, about $66 million larger than the previous year. That will weigh in at a modest 1% of GDP, though that marks a 0.7 ppt deterioration from FY21/22.
Newfoundland & Labrador
The Newfoundland & Labrador economy will see little real GDP growth this year due to some outages in the energy sector and the impact of Hurricane Fiona. However, incomes are getting a boost from surging oil prices, and rebuilding efforts will add to activity into 2023. The province was in a challenged position pre-COVID, but is emerging in better shape, with a notable boost to government royalty revenues incoming. Growth should firm very slightly to 1.2% in 2023 as oil production picks up.
While longer-term oil production remains burdened by declining reserves (Hibernia and White Rose), and a disruption at Terra Nova, Hebron continues to churn out steady output. And, the value of output has surged alongside higher prices.
The unemployment rate is well down from 2020 highs, sitting around the 10% level as of mid-2022. Employment has recovered all of the losses seen over the past two years, but the longer-term trend is likely stable around current levels. Tourism-related employment remains a clear weak spot, and part-time jobs have driven recent gains.
The Province of Newfoundland & Labrador is projecting a $351 million deficit for FY22/23, but there is upside building thanks to above-budgeted oil prices. That weighs in at less than 1% of GDP, a stark improvement from recent years.