Is a recession on the horizon?

As the Bank of Canada tries to tame inflation and simultaneously guide the economy to a soft landing, most market participants are skeptical that it can pull off this feat.

After months of steep interest rate increases, the impact of higher borrowing costs is only beginning to be felt in Canada's real economy.

A recession, albeit mild and brief, is most likely on the horizon. Our forecast puts the chance of a recession at 60 per cent this year , with the downturn hitting the economy unevenly.

We will not be able to determine if a recession has officially begun until the C.D. Howe Institute's Business Cycle Councill—an arbiter of business cycle dates in Canadal—announces its decision.

Keep in mind it took the council more than a year to officially announce the end of the most recent recession.

However, by replicating the criteria used to identify when a recession begins and ends, we can track the start and end dates much sooner. Here are the top indicators we can monitor, according to the council's past reports: GDP, job growth (from payroll and labour force surveys), and industrial sales.

The past two recessions featured sharp declines in the growth rates of all indicators. Following the same analysis, the Canadian economy has not been in a recession since the pandemic as industrial sales and jobs have remained solid, especially in the first quarter of this year.

But the economy has shown signs of a slowdown as steep interest rate hikes continue to put pressure on borrowing costs and, as a result, investment.

The U.S. economy and other Canadian trading partners will most likely experience some degree of downturn as well, adding more reasons to believe a recession is imminent.

We expect a mild and brief recession that will be spurred by restrictive monetary policies instead of by a problem with the structural foundation of the economy like what happened in 2008.

The Bank of Canada would be in a tougher position compared to 2008 because it would most likely not be able to cut rates aggressively when inflation is expected to remain around 3 per cent by year's end.

But it would still be a much easier job compared to the one faced by the Federal Reserve, which is struggling with higher inflation and more rate hikes to go in the United States.

We still expect 40 per cent of the economy to achieve a soft landing and avoid a recession. The key factor will again depend on the labour market, which can either sink or lift the economy almost single-handedly.

The takeaway

The Canadian economy is preparing for a period when there are likely to be more job losses than gains.

Like almost all other central banks in the world after the pandemic, the Bank of Canada has faced the difficult task of trying to balance economic growth with price stability.

While we believe there will be some turbulence during the landing, the economic setbacks will most likely be tempered as the labour market shows residual strength.