OECD Economic Outlook, Volume 2023 Issue 1

Canada

Real GDP growth will decline to 1.4% in 2023. Higher borrowing costs will weigh on activity. Lower commodity prices have unwound last year’s terms of trade gains. Demand will strengthen through 2024, but annual output growth will remain below the economy’s long-run potential rate at 1.4%. Exports will benefit from improved global conditions, while immigration boosts private spending and labour supply. Price pressures will ebb as the jobless rate rises from recent lows. An investment recovery next year could be upended if credit conditions worsen, a risk that has increased with volatility abroad.

Monetary policy should remain tight, with the policy interest rate kept at its current level until inflation nears target in 2024. Reduced fiscal support should help cool demand as living-cost relief is withdrawn. Reversing provincial fuel tax concessions would complement incentives for green investment, which the federal government is scaling up. In parallel to efforts to remove internal trade barriers, more can be done to facilitate labour mobility. Paring back stringent limits on densification could allow more housing in cities. This would head off future housing price pressures as population inflows increase.

Inflation has fallen despite solid output and employment gains

Economic growth was stronger than expected in the first quarter of 2023. Growth in manufacturing, construction and services more than offset production declines in natural resources industries. Higher borrowing costs continue to weigh on housing‑market activity. Metropolitan housing prices and home sales are lower than a year ago but seem to be stabilising. Market expectations of lower interest rates next year are yet to translate into a sustained rise in building approvals, which should precede a residential construction recovery. Higher credit costs and weak sales growth expectations are weighing on business investment intentions. Retail activity has defied expectations of a downturn despite high inflation eroding purchasing power. Population growth is supporting total consumers’ expenditure, but average spending per person is little changed from pre-pandemic levels in real terms. Consumer surveys report heightened uncertainty about the economic outlook, consistent with still-high household saving rates.

Canada: Inflation and activity indicators

Source: OECD Economic Outlook 113 database; Statistics Canada.

Statlink

Canada: Demand, output and prices

Statlink

Canada: Economic growth indicators

1. Total consumption and investment (including inventory variations) less total imports of goods and services. National accounts data do not disaggregate imports by expenditure component of GDP and intermediate inputs. In practice, imported value added forms part of consumption, investment and also exported goods and services.

Source: OECD Economic Outlook 113 database.

Statlink

The labour market remains tight. Recent job gains have broadly matched growth in the labour force, keeping the unemployment rate near record lows. Large numbers of new arrivals to Canada appear to be helping relieve skill shortages. Reduced job vacancies point to future moderation in labour demand. Consumer price growth has dropped rapidly with lower energy prices, reduced food price inflation, and lower input costs being passed through to the price of finished goods. In April, year-on-year growth in the headline consumer price index was 4.4%, well below the peak of 8.1% in June 2022. Underlying price pressures have also declined, but more gradually. Wage growth is elevated and now exceeds consumer price growth.

Crude oil price falls have left Canada’s commodity export prices well below peaks attained in mid-2022. The terms-of-trade decline has caused a negative income shock, reflected in a lower non-financial corporate operating surplus. Farm output volumes have declined from highs recorded last year amid good growing conditions. Volatility in US and European financial markets prompted comparatively modest tightening in financial conditions in Canada. Still, credit growth has slowed, particularly loans to households.

Macroeconomic policies are helping rein in excess demand

Contractionary monetary policy is cooling demand – which currently exceeds the economy’s sustainable productive capacity – and helping to re-anchor inflation expectations. To durably return inflation to target, the policy rate will need to remain at its current level of 4.5% until mid-2024. With output expected to be close to potential in the second half of next year, the policy rate should be lowered towards more neutral levels. The projections factor in a 50-basis-point decline in the benchmark interest rate by the end of 2024. Gradual quantitative tightening is assumed to continue through 2023-24, putting some upward pressure on borrowing costs.

Fiscal deficits will narrow over the next two years. Revenue growth will decline with weaker growth in nominal GDP and business profits. The federal budget announced new spending on healthcare and incentives to spur green investment. Separately, some federal and provincial measures continue to cushion household balance sheets from living cost pressures. In March, the federal government announced a further increase in goods and services tax credits targeting lower‑income households hit hard by high food prices. Provinces including Alberta and Ontario have kept in place measures reducing or suspending fuel taxes, despite energy cost falls. A withdrawal of remaining inflation relief initiatives by the end of 2023 is assumed to contribute to improving fiscal balances in 2024, reducing support to economic activity.

Slowing domestic activity will weigh on GDP this year

Real GDP growth is projected to moderate to 1.4% in 2023. The slowing US economy will weigh on Canada’s exports after a strong first quarter outcome. Higher credit costs and a subdued demand outlook will cause businesses to postpone capital expenditure plans. Further declines in housing investment in the first half of the year will also contribute to lower private gross fixed capital formation. Private consumption growth will slow, but is expected to remain positive. High rates of household formation will help to offset the impact of higher borrowing costs and weak growth in real incomes. Economic activity will strengthen through 2024 but annual growth will remain below potential at 1.4%. Job creation will slow relative to population growth and the unemployment rate will rise. Wage growth will moderate but remain higher than consumer price inflation, which is projected to return to target by the end of next year. Improved purchasing power will support consumer spending while increased housing demand drives a recovery in residential investment. Exports and business investment will pick up with strengthening foreign demand.

Considerable uncertainty surrounds the outlook. High household debt levels and increased mortgage servicing costs could cause private consumption to contract, particularly if job creation slows more than expected. Increased volatility in major financial markets might translate into tighter credit conditions in Canada, risking deeper falls in business investment. In contrast, high levels of immigration should, in the near term, slow population ageing and could push GDP growth above projections. Beyond direct payoffs from a larger working‑age population, newcomers' skills and higher workforce participation might further expand the economy’s productive capacity. This could enable stronger demand without accelerating inflation.

Lower inflation has removed the need for extraordinary living-cost relief

With inflation returning to moderate levels, federal and provincial governments should withdraw remaining living-cost relief amid broader efforts to reduce fiscal stimulus to the economy. Reversing provincial utility bills and fuel tax subsidies would support energy saving and complement measures aimed at boosting investment in green industries. Progress in lowering childcare costs will reduce employment disincentives for second earners, more often women than men. Broader improvements in the business climate will require policy progress at all levels of government towards making markets more efficient. Alongside efforts to shrink barriers to internal trade in goods and services, more can be done to remove obstacles to labour mobility. High costs of housing can make it hard for people to pursue jobs in high-wage, high-productivity cities. Paring back constraints on densification in urban areas, while investing in infrastructure, would help accommodate new residents and limit future growth in housing costs.