OECD Economic Outlook, Volume 2022 Issue 2

Canada

Growth in real GDP is projected to slow from 3.2% this year to 1% in 2023 before strengthening to 1.3% in 2024. Higher borrowing costs will weigh on consumer spending while export growth moderates in the near term amid deteriorating conditions abroad. Softer aggregate demand will relieve pressure on capacity, aided by continued recovery in non-housing investment. Labour markets have been tight until recently, but hiring will decline with slower output growth. Wage growth will moderate as the unemployment rate settles slightly above pre-pandemic levels. Inflation will converge on target as underlying cost drivers ease and remaining supply bottlenecks clear.

Large interest rate rises this year will help check excess demand and tame inflationary pressures. The pace of monetary tightening should slow if labour markets show signs of deteriorating. Living-cost relief is weighing on fiscal balances in 2022. Federal and provincial governments should scale back support as price pressures abate. This will reduce fiscal deficits next year and help temper aggregate demand. A raft of measures have been developed to ensure long-term growth in Canada’s economy is sustainable. Low-cost emissions mitigation depends on improving policy instruments such as carbon pricing, while supporting green investment.

Economic activity is cooling

Strength in Canada’s resources sectors has helped offset slower growth in services. Industry GDP data suggest activity has cooled after an earlier post-pandemic rebound in hard-hit sectors including travel and accommodation. Business sentiment dipped in the third quarter on expectations of slower sales. Investment and hiring intentions have moderated and firms are starting to report easing capacity pressures. While job vacancies and employment remain near highs seen earlier in the year, job growth has slowed relative to population increases. Larger-than-usual migration inflows from other countries are helping to fill positions in some sectors. Canada ramped up permanent immigration programmes after international borders re-opened. The country has also welcomed large numbers of Ukrainian refugees; over 375 000 applications have been approved, equivalent to 1% of Canada’s population. The latest Bank of Canada Survey of Consumer Expectations showed that tighter credit conditions and a weaker economic outlook are weighing on consumer sentiment. Retail trade has softened recently, consistent with real wage declines. Dwelling investment continues to slip from high levels registered during the COVID-19 crisis. Higher borrowing costs are weighing on housing market activity, and sales are significantly down on year‑ago levels. Housing price declines have been particularly large in markets such as Toronto that experienced strong growth in recent years, but many cities have seen falls in property values in recent months.

Canada 1

1. The policy rate is the Bank of Canada's target average rate for overnight money market financing.

Source: OECD Economic Outlook 112 database.

Statlink

Canada: Demand, output and prices

Statlink

Canada 2

1. Flash estimate for September 2022.

Source: Statistics Canada via Refinitiv.

Statlink

Canada’s remoteness from hard-hit European markets and its domestic oil and gas capacity continue to help shield the country from acute economic pressures arising from Russia’s war of aggression against Ukraine. Energy price rises in particular have been lower than in Europe. Lower petroleum prices has helped to reduce consumer price inflation from its peaks earlier in the year. Growth in the headline consumer price index has declined from 8.1% in June to 6.9% in October (year-on-year). Food and services price inflation remains high, although businesses’ inflation expectations eased slightly in the third quarter.

Near-term policy goals are to tame inflation and provide living-cost relief

Further near-term monetary policy tightening is needed to bring consumer price inflation to target. But the central bank will need to remain alert to evolving labour market conditions to avoid overcorrecting. The policy rate is projected to increase by a further 50 basis points by the end of the year. Quantitative tightening will continue to put upward pressure on longer-term interest rates. While remaining contractionary over much of the next two years, the monetary stance is assumed to start to ease in 2024 as price pressures diminish. From a peak of 4.25 per cent, the policy interest rate is assumed to decline by 50 basis points by the end of 2024.

Broad-based fuel tax cuts and energy bill rebates introduced in some provinces have been extended. To help offset the effects of high inflation, the federal government has boosted the goods and services tax credit available to low-income households, a measure worth around 0.1 per cent of GDP. The fiscal cost of provincial and federal living-cost support is modest compared with that provided in other OECD countries.

Inflation will moderate as growth slows

Real GDP growth is projected to slow to 1% in 2023. Weaker conditions in the United States and other major economies will pull down export growth. Higher interest rates are expected to weigh on growth in housing investment and private consumption, despite support from population increases. Business investment will continue to recover from low levels during the COVID-19 crisis, aided by expenditure on health and public transport systems as well as large energy sector projects. Labour demand will ease with slower growth in production, causing employment growth to slow. GDP is projected to grow by 1.3% in 2024. Subdued domestic demand will be offset by stronger export growth due to improving conditions in Canada’s main trading partners. Higher unemployment will check wage growth in the next two years, helping to alleviate pressure on consumer prices after declines in the cost of energy, food and housing.

Risks to the near-term outlook are tilted to the downside. Wage pressures might not dissipate as soon as expected. Tackling higher inflation could require larger interest rate increases, putting more pressure on sectors sensitive to borrowing costs, particularly those tied to housing market activity. Home prices may prove more sensitive to higher interest rates than assumed in the projections. A significant deterioration in property values might cause broader financial market instability, with negative wealth effects dragging on consumer spending.

Staying focused on sustainable long-term growth

Canada’s federal and provincial governments should scale back and re-target living cost relief as price pressures abate. The withdrawal of relief measures will help to improve fiscal balances and ensure fiscal policy does not work against tighter monetary policy. While navigating the current uncertain macroeconomic environment, Canadian governments should keep sight of structural policy priorities for strengthening long-term growth. Successful implementation of the major federal government initiative to improve access to affordable childcare could support labour force participation. Boosting investment and productivity will depend in part on efforts to address barriers to trade between provinces, which limit cross‑border flows of goods and services and impede labour reallocation. To ensure it achieves its ambitious climate targets, the federal government is developing a raft of mitigation policies. Alongside the main aim of reducing emissions, policies should be designed to minimise costs. Improving existing market‑based measures such as carbon pricing should be a priority. Support for investment in green technology will help ensure that Canada builds on its comparative advantage as a supplier of low-carbon electricity and goods.