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Canada and the U.S. may yet avoid recession, but barely, says BMO Capital Markets, which downgraded its economic forecasts for both countries.

In a new report, BMO economists cut their 2023 North American growth forecasts by half a percentage point, reducing their real GDP projection to just 0.5% in the U.S. and to 1.0% in Canada, citing the effects of weaker economic data and tighter monetary policy.

“Both economies will likely contract in at least one quarter near the turn of the year,” the report said. “Our outlook might not qualify as an official recession, but it will feel like one for many businesses and some workers.”

The U.S. in particular has already felt some of that pain, with output contracting in the second quarter of this year; yet, it is still “probably not in recession,” BMO said. “In fact, recent data suggest real GDP will rebound at least modestly in Q3.”

While Canada held up better in the second quarter, BMO noted that more recent data suggest that “activity is weakening,” and it now expects real GDP growth of just 1.0% in the third quarter.

The world economy isn’t doing much better.

“The global economy continues to weaken, with Europe’s energy crisis threatening to tip the continent into recession, and China’s pandemic lockdowns casting a pall over Asia,” the report said.

And, with inflation still elevated, the world’s central banks are expected to keep tightening monetary policy.

The Bank of Canada has now raised rates by 300 basis points (bps).

“We look for one final 50 bps hike to 3.75% in October, before the Bank moves to the sidelines as the economy stalls and inflation falls,” BMO said, adding that it will be early 2024 before rates starting sliding again.

It expects the U.S. Federal Reserve to continue raising rates to the 3.75% to 4.0% range, with another 75 bps hike on Sept. 21, “followed by 50 bps and 25 bps moves in the final two months of the year,” it said.

Already, there are signs that inflationary pressures are starting to ease, including lower commodity prices and reduced supply chain bottlenecks.

“Perhaps the best news is that most measures of long-term inflation expectations have eased a bit, giving central banks some breathing room,” BMO said.

Still, it will take time for inflation to subside, the report noted.

“Stubborn inflation continues to pose the single biggest threat to the economy,” the report cautioned, adding that this would require even tighter monetary policy than currently expected.

“If so, there won’t be much debate about whether the economy can avoid a deep downturn,” it said.