Even if inflation has peaked, the possibility of Canada slipping into a recession is not off the table yet, CIBC’s chief economist says.
“There are still several ways in which Canada could move from what’s supposed to be only a slowdown in growth into an outright recession,” said Avery Shenfeld.
For one, if the Federal Reserve raises rates too far and forces the U.S. into a recession, it will almost inevitably lead to a recession in Canada, Shenfeld said.
Last week, Federal Reserve chair Jerome Powell said the central bank was determined to fight inflation with more sharp interest rate hikes.
Europe is also on the cusp of a recession as the fallout from the war in Ukraine and the impact on natural gas prices drags on European consumers.
A global recession could feed back into Canada, Shenfeld said, and the Bank of Canada could also send the economy into a recession with more rate hikes of its own.
“We think the odds of a recession in the next year and a half are probably in the vicinity of 40%, which is quite a bit higher than it would be in a typical year,” he said.
But how bad would a recession be?
According to Shenfeld, if a recession were caused by interest rate hikes — with key rates in the 3.5% to 4% range — central banks would have some room to provide relief, particularly if inflation came down as a result. Inflation slowed in both Canada and the U.S. in July, leading some economists to hope it has peaked.
In that case, a recession could be short with economic growth returning in 2024, Shenfeld said. However, governments would have little room to spend their way out of a recession since “they did a lot of that during the pandemic,” he said.
One risk is what’s happening in the U.K., where the Bank of England recently raised interest rates by half a percentage point despite forecasting a recession — “and not a particularly mild one” — next year, Shenfeld said.
“That’s a very unusual circumstance that a central bank would almost deliberately be forcing a recession because they have reached the judgment in the U.K. that inflation will be so elevated that it will take a recession to get it under control,” he said.
The good news for Canadians is that the Bank of Canada has not come to the same conclusion. The central bank is still projecting GDP growth, indicating that it doesn’t believe it will take a recession to get inflation under control — at least not yet, Shenfeld said.
That seems to be true for the Federal Reserve as well. The U.S. central bank sees several factors contributing to the current levels of inflation, Shenfeld said — including the war in Ukraine and ongoing supply-chain issues — and believes some relief on those fronts could tame inflation.
Even if Canada were to avoid a recession, though, Shenfeld said it wouldn’t prevent some sectors declining.
The most interest-sensitive sectors of the economy — such as real estate — are already in a recession to some extent, Shenfeld said, with the number of housing transactions in decline.
So, while there is still hope that the overall economy in Canada can escape a recession, interest-sensitive sectors may not be so fortunate, Shenfeld said.
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