Incoming data suggests that the Canadian economy is facing increasing challenges and slower growth. The rise in household debt servicing burden due to past monetary tightening and a softening business outlook indicated by forward-looking surveys contribute to this trend. As a result, our forecast for Canadian GDP growth has been lowered to 1.1% for 2023 and 0.7% for 2024. Inflation remains elevated, although Canada’s September CPI came in lower than expected. The Bank of Canada (BoC) has maintained its policy rate at 5.00% and a moderate tightening bias, but we believe this marks the peak of interest rates. We anticipate that the BoC will maintain the policy rate for an extended period before implementing rate cuts in Q2-2024 due to slower growth and inflation compared to the central bank’s expectations. With subdued Canadian growth and no further tightening by the BoC, we also expect potential weakness in the Canadian dollar in the coming months.
The challenges to Canadian growth are becoming more apparent. While the labor market has shown some strength, with job additions and elevated wage growth, the overall employment gains do not paint a complete picture. Full-time job gains accounted for less than half of the increase, and the growth in private sector employees declined while public sector employees and self-employment increased. Other areas of the economy, such as retail sales, have declined for three consecutive months, indicating consumer caution due to higher interest rates and cost-of-living issues. Canada’s Q2 GDP growth contracted, and economic fundamentals and forward-looking indicators do not suggest an improvement in growth prospects. Rising interest and debt servicing burden for households and declining corporate profit growth contribute to the subdued outlook for both consumers and businesses.
While Canadian growth has been disappointing, the news on inflation is slightly more hopeful. Actual inflation data and forward-looking indicators show that inflation is gradually heading in the right direction, although it remains too high for now. The September CPI surprised to the downside, and survey data also indicate a favorable direction for inflation trends. The BoC’s Business Outlook Survey shows that firms expect slower input and output price inflation over the next 12 months. Consumer surveys indicate elevated inflation expectations but also suggest that higher interest rates are influencing consumer behavior.
In light of slowing growth and gradually slowing inflation, the Bank of Canada decided to keep its policy interest rate steady at 5.00%. The central bank acknowledges softer economic activity and a weak growth outlook. The BoC maintains a moderate rate hike bias but remains concerned about slow progress towards price stability and increased inflationary risks. While the central bank is open to further tightening, we believe further rate cuts are more likely due to our forecast of slower economic growth and slightly slower CPI inflation than what the central bank expects. Therefore, we anticipate the Bank of Canada will keep its policy rate steady for an extended period before implementing rate cuts starting in Q2-2024, totaling 150 bps of easing to 3.50% by the end of next year. With subdued growth and no further tightening by the BoC, we also expect potential weakness in the Canadian dollar, with the USD/CAD exchange rate possibly moving closer to CAD1.4000 over the next several months.
