Research Briefing | Dec 14, 2022

Tight financial conditions suggest Canadian economy hit a turning point

Financial conditions in Canada have tightened significantly this year and we estimate this will shave 0.7ppts off GDP growth by the end of 2023. It takes time for tighter financial conditions to fully affect the economy, but our modelling suggests the negative impact on GDP will be largest in Q4 2022 (-0.2ppts). This reaffirms our view that the economy has hit a turning point and a moderate recession is likely now underway.

What you will learn:

  • Financial conditions are the tightest they’ve been since the onset of the pandemic, according to our Financial Conditions Index (FCI), but to date remain better than during the Global Financial Crisis (GFC). This worsening in the financial environment can be attributed to aggressive rate hikes by the Bank of Canada, quantitative tightening (QT), widening corporate spreads, a severely inverted yield curve, and a significant correction in equities.
  • Like monetary policy, the full impact of changes in financial conditions tends to take about 6-8 quarters to work through the economy but we find changes in financial conditions affect the economy with less of a lag.
  • There are risks that financial market conditions could be an even bigger drag on the economy. Our approach only captures past changes in financial conditions, so if the financial environment remains restrictive for a prolonged period it would lead to an even larger drag on GDP growth going forward.
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