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Avery Shenfeld, chief economist at CIBC.
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. Of course, if that happens in the U.S., because they raise interest rates too far, historically, that’s almost inevitably led to a recession in Canada. Europe is on the cusp of a potential recession associated not just with inflation and high interest rates or rising interest rates, but also with the fall out from the war in Ukraine and the impact on natural gas prices, which is squeezing the consumer in Europe as a result. So a global recession could feed back into Canada as well as, of course, we could end up with too much of an interest rate hike environment, and that could send us into recession.
The question is, how bad would a recession be? One plus is that if it is caused by interest rate hikes that end up being a bit too excessive, the central banks, having raised interest rates say to 3-1/2 or 4%, would now have some room to provide relief, particularly if inflation has come down as a result of that recession. So, that could shorten the period of a recession in that case. One hazard here is that in terms of the other avenue for getting out of a recession, which is governments spending more money, they did a lot of that during the pandemic. And it’s a question mark as to whether in the US or Canada governments would be as willing to open up the taps again to fight the next recession.
So, that still gives us some risks. We think that 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. But there’s certainly a reasonable chance that if we were to fall into a recession, and if that did provide some rapid relief on the inflation front, that Central banks would find room to start cutting interest rates and drive economic growth back into the plus column for 2024.
What’s notable is that if we look over at the U.K., for example, The Bank of England recently raised interest rates a half a percent. But also at the same time, the official forecast from the central bank was for an outright recession and not a particularly mild one, in 2023. And 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. The good news for Canadians is that’s not a conclusion that the Central Bank in Canada has reached yet. The Bank of Canada is still actually projecting somewhat faster GDP growth than CIBC’s own forecast. So it’s clearly indicating that it doesn’t yet believe that it’s going to take a recession in order to get inflation under control.
And that still seems to be the leaning of the Federal Reserve in the US as well. That they see a number of factors driving the current inflation that we’ve been observing, including the war in Ukraine, some of the production difficulties associated with the pandemic, and they see relief on some of those fronts as providing some of the downward push to inflation rather than deliberately steering either the U.S. or Canada into a recession to get inflation under control.
It’s also worth noting that even if Canada were to avoid a recession for the economy as a whole, that doesn’t preclude some sectors of the economy seeing an outright decline. The most interest-sensitive sectors of the economy, in particularly real estate, are to some extent already in a recession. So the number of housing transactions, for example, which determines the output of the real estate agent sector, that’s already in decline. We are seeing the signs of a slowing coming in construction as some condo projects are delayed.
So the overall economy can still escape recession. But in an environment where the central banks have been raising interest rates with an effort to slow economic growth, they will send some interest-sensitive sectors into outright declines.