Economic forecasts: 7 questions to Jimmy Jean and Emna Braham

How do things stand in 2024? Expectations for rate cuts in the US have fallen, but what about Canada? What can we glean from the most recent government budgets? Will the housing market start to overheat again or will rate cuts just get things moving again?

Many of you attended the web conference with Vice-President, Chief Economist and Strategist Jimmy Jean and Executive Director of the Institut du Québec, Emna Braham, who reviewed the most recent economic and financial forecasts. A number of you asked questions during the meeting.

Here are the answers to the 7 most frequently asked questions during the presentation. You can also watch a playback of the webconference here.

2024 was a tough year for businesses. Along with the first Canada Emergency Business Account loan repayment date, we saw a sharp rise in insolvencies. The Trudeau government then introduced another measure that could cause additional uncertainty by increasing the capital gains inclusion rate. Considering that 55% of revenues generated by this measure will stem from corporate taxes, it's obvious that high-net-worth individuals aren't the only ones who will be affected. But it's impossible to know what the actual impacts will be just yet. The measure sends a negative signal that could disincentivize certain businesses from growing, and may also discourage people from investing in Canada. On the other hand, inclusion rates are even higher in other countries, including in the United States. But companies need to be encouraged to invest, not the other way around.

Canada’s monetary policy isn’t pegged to the US. Both central banks often make similar moves broadly speaking, but there have been many times when the Bank of Canada wasn't afraid to go its own way, even if that meant the loonie would fall. Interest rate spreads are an important variable, but their influence on the currency tends to fluctuate over time. Since the pandemic, this variable hasn't been as significant as other factors. Moreover, even if Canada's currency did depreciate significantly, the pass-through of exchange rate movements to inflation tends to be small. That's in part because imported goods and services don't carry a lot of weight when it comes to headline inflation. You can read more about this here.

The various levels of government are working hard to meet the country's needs. Incentivizing major manufacturers in the green sector to set up shop in Canada and removing obstacles that are delaying new housing projects (through the Housing Accelerator Fund, for instance) are just some of the measures that have been put in place to stimulate private investment. This could help boost productivity (which fell in the first quarter of 2024) in a number of ways. For example, resolving the housing crisis would help Canada attract and retain crucial talent for growth and innovation. Securing Canada's position as a critical minerals superpower through the mining industries of Ontario and Quebec will require significant infrastructure investments—an important driver of economic development across the country. In practice, however, several obstacles will need to be eliminated before these investments can become a reality. Making sure we have enough skilled workers ranks high on the list. Borrowing costs will also need to be low enough for projects to be viable, private investors will need to be involved and governments will need to be provide visibility about their policies. 

Homeowners with variable-rate mortgages are most likely celebrating the announcement made by the Bank of Canada on June 5, since they were hit hardest by the interest rate hikes we saw over the last 2 years. Variable rates are based on the prime rate set by financial institutions, and the prime rate tends to be adjusted alongside changes in the BoC's overnight rate. When policy interest rates started going up in March 2022, more than 50% of borrowers had a variable rate. This was unusual, since this percentage had been closer to 20% in previous years. Homeowners with fixed-rate mortgages will feel the impact once their mortgages are up for renewal, provided those mortgage rates come down too. Even though fixed-rate mortgages are influenced by the overnight rate, they are less directly affected, and can be influenced by other factors. We'll delve further into this topic in an upcoming Economic Viewpoint that's slated to be published in the next few weeks. 

We need to keep an eye on the latent effects of monetary tightening. In the United States, for instance, recent numbers point to a significant cooldown and there are signs that the labour market is slackening. This could lead to a deterioration in American consumers’ credit quality. In a pessimistic scenario, recession fears could start to resurface in the United States. This is relevant for Canada, because we would have a hard time weathering a US recession. In fact, one of the main reasons Canada was able to dodge a recession in 2023 was the strength of the US economy. The upcoming US presidential election is also a source of uncertainty. If Donald Trump were to be re-elected, it could spell bad news for major US trade partners—and that includes Canada. Closer to home, we'll need to keep an eye on potential labour strikes in the rail and marine transportation industry. Drawn out conflicts could seriously disrupt local supply chains and drive up costs. More optimistically, perhaps, generative artificial intelligence is promising increased productivity and efficiency in the job market, although this technology will require strict regulations and substantial investment in IT components. For a more detailed overview of long-term risks and issues, see our recent article.

As discussed in a recent Economic Viewpoint, it's expected that the reduction in temporary residents, which is slated to take effect in the fall of 2024, will hold back growth in 2025 and 2026. This will partly offset the acceleration we're hoping to see as a result of interest rate cuts. The job vacancy rate, which is almost back to pre-pandemic levels, could increase slightly since employers will likely find it harder to replace temporary foreign workers who leave the country. Most people who are able to work are already gainfully employed at the moment. Businesses will need to get creative and do more with less, either through automation or by shifting to a digital business model. These investments will have the added benefit of making those businesses more prosperous and competitive over the long term. 

Technically, Canada's Minister of Finance, Chrystia Freeland, kept her promise to maintain the 2023–2024 deficit at or below $40 billion—at least this was the case when the budget was tabled on April 16. And yet new statistics show that Canada's deficit was slightly higher than that. As mentioned in our last budget analysis, we're not convinced the federal government will be able to reach its budget targets over the next few years. To meet fiscal anchors, it had to hike taxes by increasing the capital gains inclusion rate. These tax hikes mainly target medium and large corporations, as well as individuals in higher tax brackets. But those taxpayers could use different strategies to reduce their tax burden, thus limiting the fiscal impact of the measure. In theory, failure to meet fiscal anchors is likely to raise eyebrows at rating agencies. But Canada's public finances are still in good shape relative to peers, even when we include the provinces. And the substantial increases in spending are a natural consequence of strong demographic growth and inflation. When we adjust for this reality, as we did in our report on the 2024 provincial budget season, the spending increases don't look unreasonable.