What are the risk factors that could lead to economic downturn?
The probability of a recession in Canada is at “about 50-50,” said the Conference Board of Canada in a recently published report called ‘Pandemic, Inflation, and War: Assessing the Risk of Recession.’
Describing the “dramatic change and volatility” brought by the last couple of years to Canada’s economy, the report pointed to different factors that could tip the scale either way.
On one hand, the economy is set for slow but continued growth, with GDP forecast to grow 3.5% in 2022 and 1.9% in 2023. “Our baseline forecast does not call for a recession,” the report said. Consumer spending is expected to be the primary driver of this forecast, with bankruptcy at record lows and households amassing savings over the course of the pandemic. Labour markets are also “as tight as they have ever been,” allowing for acceleration in wage increases. And even as wages lag behind inflation, consumer spending seems to be holding up, allowing a commodity price boom that will “serve to boost Canadian exports.”
“For these reasons, we believe Canada’s economy will outperform that of many other countries around the world, assuming that nothing goes terribly wrong,” the report said.
But what are the things that could go wrong?
One risk is the loss of confidence in the central bank’s ability to curb inflation by hiking interest rates. Bank of Canada governor Tiff Macklem recently wrote in an op-ed that they are aiming for a “soft landing,” but the Conference Board report argued that monetary policies might not be enough to stem a problem that isn’t confined to “any one economy.”
Higher interest rates may, in fact, lead to a collapse in asset values. As noted in the report, assets highly dependent on borrowing, such as housing, have already started to drop. With interest costs starting to account for a higher percentage of mortgage payments, the price that homeowners are able to afford is reduced.
“Sales of homes in Canada have plummeted over the past few months and prices are coming down,” the report said, adding that a continued downturn will cause a severe collapse that “could cause a large reduction in home building, distress households, and boost mortgage default rates” might be on the way.
One other risk that could tip Canada’s economy toward recession are COVID-related health measures, given that BA.5 seems to more transmissible and virulent than other COVID variants. Another round of widespread closures will hinder global supply chains further, “adding weight to a potential downturn in the world economy.”
An escalation of Russia’s war on Ukraine is the final risk factor determined by the Conference Board of Canada. At present, the global commodity price shock caused by the war seems to have peaked. However, increased war tensions and sanctions could easily cause prices to rise once again. Such a situation would “intensify the challenge central banks face in trying to manage a soft landing,” the report said.
