No Imminent Canadian Recession, but Can the Bank of Canada Stick the Soft Landing?

As central banks around the world began aggressively raising interest rates in early 2022, like many economists we expected recessions in the US, Canada, Europe and beyond. In many countries, this call proved correct. However, in others, real GDP growth managed to stay in positive territory. In the US, for example, substantial pandemic-era savings and a preponderance of 30‑year mortgages managed to mitigate the drag from elevated inflation and interest rates.

In Canada, surging population growth has masked underlying weakness in the economy. Growth has managed to stay above water despite labour productivity and real GDP per capita declining regularly over the past two years. And while we can’t know with certainty, this suggests that a recession may not have been so easily avoided if population growth had been in line with historical norms. That’s in large part because high levels of household debt make Canada’s economy more sensitive to changes in interest rates than the economies of many other countries.

Despite the federal government making regular announcements about slowing the pace of population growth, this has yet to be borne out in the data. Growth in the number of young workers has hit a particularly torrid pace, advancing by a record-breaking nearly 8% year-over-year in August. But these new entrants into the Canadian labour force, mostly non-permanent residents (NPRs), have been struggling to find work recently. This has pushed up the unemployment rates of both youth and newcomers—two groups whose members significantly overlap (graph 1). Indeed, in the latest year for which data are available, about one third of new immigrants and over 50% of NPRs (which include international students and temporary foreign workers) were under the age of 25.

As the youth and newcomer unemployment rates have risen substantially, this has caused the overall unemployment rate to rise as well. At 6.6% in August, it is much higher than the record low of under 5.0% reached in December 2022.

This jump in the unemployment rate has led some to wonder if a recession may be coming, if Canada’s economy isn’t in one already. But it’s important to understand what a recession is and what it isn’t before making such a bold call. Specifically, recessions are characterized by their depth (negative real GDP growth), duration (at least two consecutive quarters) and diffusion (there must be broad weakness throughout the economy).

First, the Canadian economy is not in recession currently. Not even close. It expanded at a 2.1% pace in Q2 2024, beating the expectations of economists, including those at the Bank of Canada. That said, as we wrote External link. following the release, there was a lot more weakness in Q2 real GDP than the headline number would suggest. Most of the growth came from government consumption and investment, while interest-rate-sensitive sectors of the economy contracted, like durables consumption and residential investment. And real GDP also managed to decline once again on a per capita basis.

Second, despite a flat print for June and Statistics Canada’s flash estimate for little change in July, we’re still tracking Q3 2024 real GDP growth at an annualized rate in the range of 1.0% to 1.5%. That’s hardly anything to write home about, but it’s a far cry from a recession. Growth is expected to be relatively broad-based as well (graph 2). However, as it’s about half the 2.8% pace of growth the Bank of Canada projected in its July 2024 Monetary Policy Report (MPR), there may be more slack in the economy than the Bank previously expected. When combined with the weakening in the labour market and the gradually slowing pace of inflation, additional slack in the economy has raised the possibility of an accelerated pace of rate cuts.

Finally, while we remain of the view that the Bank of Canada will cut rates by 25 basis points at each of its remaining meetings in 2024 and at six more meetings in 2025, much will depend on how growth progresses. For the final quarter of 2024, the outlook for growth still looks generally positive. That’s thanks to an expected rebound in auto production, the gradual but sustained pickup in energy sector output due to the Trans Mountain Expansion (TMX) pipeline, and a possible boost in exports to the US given the uncertainty of the presidential election. However, after 2024, a wall of mortgage renewals, a possible sharp slowing in population growth and maybe even a tougher trade environment could pose major headwinds to Canada’s economic growth. Thankfully, the Bank has plenty of room to cut rates further and faster. But the question remains: Does it have enough runway to stick the soft landing? We think so, but only time will tell.