In 2024, Canadian consumer spending will come back from the dead

Open this photo in gallery:

Craig Alexander has served as chief economist at Deloitte Canada, the Conference Board of Canada and Toronto-Dominion Bank.

A new year rapidly approaches, so it is natural to wonder what is in store for the economy. A great deal will depend on the Canadian consumer, since personal expenditure represents roughly 58 per cent of all economic activity.

It’s easy to be negative. Canadian households have been struggling with an inflation and interest-rate shock that has deeply eroded their living standards and has depressed consumer confidence. They are also burdened with vast amounts of debt, three-quarters of which is tied to real estate through mortgages and other loans. Last week, Statistics Canada reported that household debt payments as a share of after-tax income had reached a record high in the past quarter.

These factors are responsible for Canada’s weak consumer performance in 2023. Indeed, real personal expenditure, which removes the impact of prices, contracted on a per-person basis. The only reason that this contraction did not trigger a recession is that strong population growth and the additional spending by immigrants meant that aggregate consumer spending was roughly flat.

Based on early surveys, it also appears that holiday spending was weak this year, and this will create a poor handoff for consumer spending heading into 2024. It would not take much additional weakness on the consumer front to push the economy into a further contraction.

But while I said it is easy to be negative, that doesn’t mean that the weakness on the consumer front will be sustained. In fact, 2024 is likely to be a year of transition, with personal expenditure gradually improving in the second half of the year.

Inflation will continue to moderate in the months ahead, likely dropping toward a range of 2.2 per cent to 2.4 per cent by the middle of 2024. This is a moderate pace only slightly above its historical average. Recent consumer sentiment polls show that Canadians are currently significantly overestimating the pace of inflation and this likely plays a role in depressing consumer confidence. A sustained cooling of inflation should improve consumer sentiment. While past price increases won’t be reversed, wage growth will be higher than inflation, meaning that consumers will gradually get some of their purchasing power back.

Inflation will still be slightly above the Bank of Canada’s 2-per-cent target in 2024, but the cooling of inflation should still allow the central bank to lower interest rates by at least a percentage point.

Canadians that have their mortgages come up for renewal will temper their spending to help manage the higher debt service costs. However, it is important to stress that only about 36 per cent of Canadians have a mortgage and a large portion of Canadians have already adjusted to the interest-rate shock.

The Bank of Canada estimates that 47 per cent of mortgagors will have had their mortgage payments reset by the end of 2023. In 2024, an additional 18 per cent of mortgages will come up for renewal, but these individuals have had time to prepare for the higher debt service costs. And the behaviour of household savings suggests that Canadians have braced for the increase in mortgage payments.

Canadians accumulated close to $300-billion of savings during the pandemic, close to a decade’s worth of saving in normal years. This was because of a reduced ability to spend during the pandemic, a reduction in work-related spending on items such as travel to the office and large government transfers. However, as the pandemic waned, Canadians continued to save. Economists at the Royal Bank of Canada estimate that the amount of “excess” savings – that is, savings beyond what would normally be expected – has reached $376-billion. This contrasts greatly to Americans, who have been drawing down their savings and spending, which is a key reason the U.S. economy outpaced the Canadian economy in terms of growth in 2023.

What explains the difference in consumer behaviour? I suspect that most Canadian mortgage holders could see that their debt service costs were going to increase and mentally set aside their savings for this eventuality. This helps explain why personal bankruptcy and mortgage arrears have increased but have not ballooned.

Consumer confidence and spending will also likely get a lift once the Bank of Canada starts to lower interest rates, even if rates stay at a relatively high level. Once interest rates start to fall, more buyers will be attracted into real estate markets. The result will be more housing-related consumer purchases such as furniture and appliances. It will also make Canadians feel wealthier as homes appreciate in value.

All told, consumer spending is likely to start off poorly in 2024, and there is a risk that the economy posts another quarter of contraction. However, the near-term weakness in consumer demand will help bring down inflation and will set the stage for lower interest rates. Sustained lower inflation and the future easing of monetary policy should be a catalyst for improved consumer confidence, with the result that consumer spending should transition from weakness to improving growth in the second half of the new year.