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Saturday, April 13, 2024

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Canada

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GDP: USD2139.8bn (World ranking 9)
Population: 38.9mn (World ranking 37)
Form of state: Constitutional parliamentary monarchy
Head of government: Justin Trudeau (PM)
Next elections: 2025, Legislative

Strengths

  • Canada has experienced robust job creation, with an average of 40k new jobs per month, signaling strength in the labor market
  • The country boasts a stable business and political landscape with well-managed fiscal and monetary policies
  • Despite facing economic challenges, Canada has historically showed resilience, with a well managed economy and a history of maintaining a balanced fiscal and monetary approach

Weaknesses

  • Aggressive interest rate hikes by the Bank of Canada have successfully curbed inflation but have simultaneously slowed economic growth, projecting a weak GDP growth for 2024
  • Soaring housing prices, coupled with high mortgage rates and decreased activity, present challenges in the housing market, potentially impacting economic growth
  • Inflation’s cumulative effects have outpaced wage growth, impacting consumers’ purchasing power. The dwindling personal savings and reluctance to take on more debt pose challenges for sustaining consumer spending, a significant driver of economic activity

Economic overview

Slow growth in 2024

High interest rates in 2024 will continue to cool inflation, but also slow the economy such that growth in 2024 is likely to be quite weak. Indeed, the economy was just bouncing off the bottom in the second half of 2023, posting growth of -1.1% q/q annualized in Q3. On a monthly basis GDP shrank -0.2 m/m in June, -0.1% in July and 0% for August, September and October.

Yet even as the economy slows, the BoC has signaled that it will leave the overnight rate untouched at 5% into the middle of 2024, as core inflation is running at 3.5%, which is a long way from the 2% target. In addition, wage growth is currently running faster than inflation and dismal labor productivity has driven unit labor costs soaring. Clearly there are still inflationary pressures at work and a continued tight monetary policy will weigh on growth in 2024.

Even if the BoC were to keep the overnight rate at 5.0% through the first half of the year and then cut twice in the second half of the year to 4.5%, it would still be at the highest since 2007 when the BoC raised the overnight rate to slow the housing bubble. Those hikes later drove the economy into recession. The combination of already slowing growth and continued high interest rates suggests that GDP growth for all of 2024 could be +0.5% to +0.8%, with some quarters of negative or flat growth.

Other fundamentals will drag on the economy

In addition to high interest rates, other fundamentals will negatively affect the economy in 2024. For instance, inflation is still wreaking havoc on wage earners due to its cumulative effects. Since January 2021, wages have grown a cumulative 11.5%, but food has risen 20%, shelter has risen 19% and gasoline has risen 37%. Clearly wage earners are still underwater, despite recent gains.

Consumption is also poised to slow. Consumer spending accounts for about 55% of all economic activity in Canada and consumption requires money. But income is still lagging and personal savings are dwindling. Consumers could turn to credit, but they are in a precarious position to do so – Canadians are already paying a record amount of debt service compared to their incomes. The BoC’s aggressive path of interest rate hikes has driven credit card rates to record highs and has put the five-year mortgage interest rate at the highest in 15 years. Furthermore, consumer confidence is dismal.

High mortgage rates are just part of the problem which will weigh on the housing market in 2024. Housing prices have fluctuated recently, but they are still 30% to 40% higher than they were before Covid-19. As a result, housing affordability is extremely low. Furthermore, since the BoC started signalling rate increases at the end of 2021, housing activity has plummeted and has never recovered – permits are down 13%, unit sales are down 30% and the value of residential structures is down 16%. As a result, housing will continue to be a drag on potential GDP growth in 2024. In a hypothetical scenario where the BoC cuts the overnight rate by 50 bps in 2024 and the five-year mortgage follows along, it would still be the highest in 15 years, continuing to make housing unaffordable and weighing on the housing market and the economy in general. Finally, since approximately 20% of mortgages need to be refinanced every year, homeowners who borrowed at 3%-4% a few years ago will face a steep increase in mortgage payments at 6%.

Exports will also come under pressure in 2024. It is expected that the US Federal Reserve will start to cut rates sooner and will cut more in 2024 than the BoC. As such it is likely that the Canadian dollar will strengthen vs. the US dollar. Thatwill benefit consumers buying imports, but it will also hurt exporters to the US In addition. Exports to the US account for over 20% of GDP and an expected slowdown in the US will furthermore reduce demand for Canadian goods and services.

The labor market has been a bright spot, having created jobs at a strong rate and driving the unemployment rate to a record low. However, on a y/y basis, job growth slowed from 6.1% in May of 2022 to 2.5% in November 2023 and a decline that rapid is often a sign of an oncoming slowdown. The unemployment rate has risen rapidly from 5% to 5.8% in just eight months and job openings as measured by Indeed have declined by 52% in the 12 months ended in November 2023.

Most leading indicators also point to decay. The yield curve remains deeply inverted. The BoC’s Business Outlook survey has fallen for three consecutive quarters and is now well into contractionary territory and 47% of the respondents said that the effects of monetary policy are “just beginning.” The Canadian Federation of Independent Business (CFIB) Business Barometer survey projects poor business performance over the next three and 12 months. One positive leading indicator is the Ivey Purchasing Manager’s Index (PMI), which has remained in expansionary territory for all the post-Covid-19 era.

Stable business and political conditions

Despite an unfavorable outlook, Canada is an open, well- managed economy. Its fiscal and monetary policies have normally been well-balanced outside of the Covid-19 era. Canada ranks 16th out of 176 countries in The Heritage Foundation’s 2023 Index of Economic Freedom analysis. Canada ranks particularly strongly in the areas of rule of law, open markets and business freedom. It is less favorable in the areas of taxes, government and labor freedom. Politics are stable as Prime Minister Justin Trudeau was re-elected in 2021 and has held the office since 2015. The next scheduled federal election is in October 2025 for the 45th Canadian parliament.

CEOWORLD magazine - Insights - Canada