The downtown Toronto cityscape and office towers are silhouetted by the setting sun as seen from the Parliament St. and Front St. East area.Fred Lum/The Globe and Mail
Pedro Antunes is chief economist at the Conference Board of Canada.
Canada’s inflation rate has dropped below 3 per cent – the top of the Bank of Canada’s target range. However, getting inflation the rest of the way back down to 2 per cent may prove more elusive than we think. This means that higher rates for longer are possible. This could lead to stalled business revenues, skyrocketing bankruptcies, and rock-bottom consumer and business confidence.
In the current Conference Board of Canada forecast, economic growth is expected to accelerate later this year as interest rates begin to fall. But with economic growth stalled since early 2023, there are significant risks that a longer and more severe correction could occur.
Inflation has hit most developed economies in a similar way, peaking in June of 2022 in the United States and Canada, and in October, in Britain and much of Europe. Inflation came down sharply through most of 2023, as the effects of supply chain problems and higher commodity prices ebbed. However, the downward progress on inflation has slowed markedly in recent months.
U.S. inflation has been stuck above 3 per cent since June of last year and, even as Canada’s inflation rate edged below that level in January, that’s also in line with where it was at in the spring of 2023. Moreover, heightened inflation expectations persist, binding the Bank of Canada to a hawkish stand and hinting at a prolonged period of elevated interest rates.
Inflation, coupled with a steep rise in debt financing costs, is dealing a blow to consumers – one perhaps more painful than we realize. Total real household spending has stalled since the second quarter of 2023, but that flat performance has been buoyed up by an extraordinary surge in population growth.
The Conference Board estimates that real per capita consumer spending decreased by 0.7 per cent last year and, given the weak start to this year, there would likely be a decline of 1.6 per cent in 2024. This is much weaker than what occurred during the 2008-09 financial crisis and more in line with the deep recession in 1991-92 – a recession, for those that remember, caused by monetary tightening intended to beat back inflation.
Even as population growth keeps consumer spending positive this year, the business environment has deteriorated dramatically. Business revenues have stalled while financing costs and wages continue to climb. Exacerbating matters, bloated inventories plague businesses. Inventory accumulation accelerated in 2022, as supply chain issues were resolved, but sales didn’t follow, leaving businesses with massive inventories and stock-to-sales ratios reminiscent of the early nineties recession.
Stalled sales and higher costs are driving down profits, and Statistics Canada data show that corporate profits plummeted by nearly half, to just $167-billion in the third quarter of 2023 from an average of $324-billion in 2022. This is affecting the viability of many small and medium-sized businesses. Business bankruptcies, which had been trending up over the past 18 months, surged dramatically over the last few months of 2023.
The precarious balance of consumer and business confidence hangs by a thread, leaving the trajectory of Canada’s economy shrouded in uncertainty. Businesses went on a hiring spree following the pandemic closings, trying to narrow the gap on job vacancies and surging demand as the economy reopened. But the situation turned sharply last year and, despite stalled economic activity, employers have continued to hire or hold on to workers with the expectation that economic growth will rebound. The risk is that sustained economic malaise triggers job losses and further exacerbates a fragile economy.
The path to a soft landing hinges on conquering inflation. Success on this front would empower the Bank of Canada to lower interest rates, reignite consumer confidence and catalyze spending. However, failure to achieve this outcome could spell disaster, plunging an already frail economy into further turmoil.