Canada’s immigration-driven population surge of recent years has provided an enormous boost to economic growth, labour force activity and employment gains – single-handedly keeping the country out of a technical recession.
However, the immigration uplift to the Canadian economy is soon to expire, with Ottawa aiming to significantly reduce the share of temporary residents in the population by 2027. The economic implications of lower net migration will be significant.
That will come alongside more downside to inflation, and less pressure on housing affordability. Most importantly, as yearly population growth slows to less than 1 per cent from 2025 to 2027 on average (from the current 3.2 per cent), our research shows that the neutral rate will decline to around 2 per cent from the current estimate of 2.75 per cent (and compared to 2.625 per cent for the U.S.). (The neutral rate, also known as the Rstar, is the interest rate consistent with noninflationary growth.)
Canada’s population grew by 3.2 per cent in the second quarter of 2024 compared to a year ago (an additional 1.3 million people), with an increase in temporary residents (temporary workers, students and asylum seekers) accounting for two-thirds of this growth (800,000 newcomers). Over the past three years alone, the country has seen a net increase of close to 1.5 million temporary residents – from 1.3 million in mid-2021 to 2.8 million as of the 2024 second quarter. While this has helped Canada escape a recession by boosting spending (newcomers were responsible for around 30 per cent of consumption growth last year) and filling labour shortages, it has also resulted in higher rent and home prices.
Earlier this year, Ottawa announced a plan for a significant cut in temporary residents – from 6.8 per cent of the population (as of the 2024 second quarter) to 5.0 per cent by 2027. Such a reduction corresponds to a roughly 25-per-cent decline (700,000) in non-permanent residents and requires fast and drastic actions – these measures are also subject to change with a federal election coming by the end of 2025. While some temporary residents will shift out of that category by receiving permanent residency over the following years, that will not be enough to get the share of non-permanent residents to 5 per cent. The only way to achieve the target Ottawa set is for a portion of temporary residents to leave the country. The latest population projections by Statistics Canada seem to take into account the 5-per-cent target and estimate that there will be a net decline of 640,000 temporary residents by 2027, with each year resulting in a net outflow of more than 200,000.
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Such a decrease in newcomers would mean that population growth will average a little less than 1 per cent annually between 2025 and 2027 – compared to the current norm of 3 per cent.
The economic implications are mixed; while reducing immigration growth is necessary to give the economy a break from its negative impact on housing affordability and overburdening health systems, it will also expose some pre-existing underlying weaknesses in the Canadian economy.
A slowdown in population growth will lead to a 30-basis-point decline in growth of real gross domestic product (GDP) due to an immediate reduction in overall spending. As of the 2024 first quarter, GDP is up 0.5 per cent from last year (in volume terms), well below the 3-per-cent annual increase in population. So, on a population-adjusted basis, the economy is actually contracting – with real GDP per capita down 2.6 per cent year-over-year, the fifth yearly decline in a row. With the full effect of rate hikes yet to kick in (they operate with 12- to 18- month lags), the future is not looking great for economic growth without the demand-side support from rising immigration. The Bank of Canada’s estimate of annual real GDP growth of more than 2 per cent until 2026 remains overly optimistic.
Employment growth will take a big hit, but the outlook on the unemployment rate and wages are mixed. As the growth in available labour supply declines (and likely at a faster pace than job vacancies), less slack in the jobs market will exert some upward pressure on wage growth, but the downside risk remains intact, with wages still playing catch-up to the recent decline in inflation.
Slower immigration growth will alleviate some pressure on the housing market; however, the unaffordability crisis will not be solved until housing starts fully catch up to population growth. The pace of immigration has dramatically surpassed the absorptive capacity of the housing market – since 2022, there have been around 650,000 housing starts, while the population is up approximately 2.5 million.
Meanwhile, the disinflation momentum is set to continue as slower demand growth for goods and services will result in lower prices, likely dragging inflation below the lower band of the BoC’s target range of 1 to 3 per cent. Inflation is already running at 2.7 per cent year-over-year, within the control range set by the bank – and with a negative output gap set to persist till 2026 (currently at 1.6 per cent), shelter prices coming down, and consumer spending losing steam, inflation in Canada is heading toward flat.
The main driver behind the neutral rate in Canada has been the increase in the labour force, which was made possible by immigration. With immigration growth taking a step back, the working-age population and labour force will expand slower than before
For investors, the key take-away here is that the Canadian neutral rate will likely drop to around 2 per cent (from the current estimated level of 2.75 per cent) as a result of slower population growth – more than half a percentage point below the 2.625 per cent estimated in the U.S. Therefore, the BoC will need to cut much deeper (and likely faster) than the Federal Reserve in the U.S., just to get monetary policy back to a neutral stance. This not only creates room for more rate cuts and builds a bullish case for Canadian fixed income but it also signals weakness for the Canadian dollar.
Atakan Bakiskan is an economist with Rosenberg Research
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