Mid-year update – What’s next for the Canadian economy? | Canada Up Close

Hi, I’m Michael Davenport, Economist at Oxford Economics, and today I’ll be providing a mid-year update of our outlook for the Canadian economy and why we think a mild recession will hit in the middle of this year. The economy has struggled to grow since mid 2023, despite a steady boost for population growth. GDP was effectively flat for the second half of last year, and while the economy did expand 0.4% quarter on quarter in Q1, the below potential pace of growth was slower than both consensus expectations and StatCan’s preliminary estimate.

We still see signs of weak underlying economic momentum and forecast a shallow downturn in Q2 and Q3 before a tepid recovery emerges. There’s two broad sources of weakness that we think will push the economy into recession. First, the lagged impact of past rate hikes is still filtering through to highly indebted households. Recent retail sales data suggest households are beginning to rein in good spending, and we think the growing impact of mortgage renewals at higher interest rates will cause consumers to cut discretionary spending, particularly low to middle income households.

Second, a further slowing in the pace of inventory accumulation will put a large drag on GDP growth this year. Recovering global supply chains have allowed firms to restock inventories at a rapid pace, but some of this buildup was likely unintended. We expect a moderation in the pace of inventory accumulation to be a key driver of this year’s downturn.

The lagged impact of pass rate hikes will also hurt new homebuilding and curb business capital outlays. Net exports should provide a modest cushion to falling private sector domestic demand as oil starts flowing through the Trans Mountain pipeline. US demand remains strong and the Canadian dollar weakens. New federal and provincial government spending will also provide a buffer, but we don’t think it will be enough to prevent a modest recession.

The Bank of Canada delivered its first 25 basis point rate cut in June, bringing the overnight rate down to 4.75%. But Governor Macklem stressed that future rate decisions will be made one meeting at a time. It’s clear to us that the Bank will continue to ease monetary policy at a gradual pace, and we expect ten more 25 basis point rate cuts will bring the policy rate to 2.25% by the end of 2026.

But if the economy avoids the modest downturn that we predict, labor markets remain resilient or housing prices rebound quickly, the BoC may delay further easing, with an outside chance it resumes hiking.