There is a 94-per-cent chance that Canada could fall into a recession within the next 12 months, especially since the yield curve remains inverted, the Conference Board of Canada (CBC) predicts.
That prediction is one of several highlights and insights from the CBC’s latest Economic Quick Take newsletter as part of its regular recession risk forecast prognoses.
The Bank of Canada (BOC) has aggressively raised interest rates to tackle inflation, which has caused mortgage rate costs to increase and demands for homes to drop, the board said. Inflation has eased, but food, fuel and shelter costs remain elevated, affecting consumer confidence and spending.
“What happens in the U.S. impacts our economy in a profound way. Our model suggests that the risk of a U.S. recession within the next 12 months is 88 per cent,” the CBC continued. “If a recession occurs in the U.S., then this would likely spill over into Canada.”
The slope of the U.S. yield curve fell at the end of January, while excess bond premiums also declined, implying that risk appetite in the corporate bond market has waned, the newsletter said.
It’s not all doom and gloom because Canada’s labour force has been resilient, with job levels growing by 150,000 positions in January.
“Economic conditions would be much worse had the labour market not been tight,” it pointed out.
Negative outlook on markets
The Canadian yield curve inverted in August, while its slope has trended downward since then, which signals that investors have a negative outlook on financial markets, said the newsletter. The BOC’s aggressive tightening monetary policy can explain why investor sentiment has dampened recently.
Further, households continue to cope with elevated prices — especially at grocery stores and gas pumps — that have caused consumer confidence to decline and growth in consumer spending to decelerate.
“According to our Index of Consumer Confidence, 76.3 per cent of respondents felt that their future financial situations would be the same or worse — a 1.5 percentage points increase from last month,” the CBC said.
Since consumption makes up more than 60 per cent of the economy, if consumers continue to have a negative outlook on the economy and spend less, recession fears could become a self-fulfilling prophecy.
Unequal recessions
A recession is defined as a decline in economic activity, significantly below potential, affecting many sectors and lasting longer than a few months, the CBC continued. The board’s recession probabilities are broadly based on this holistic approach and not the typical two-quarters of negative growth approach.
“This definition allows us to explore the severity of past and future recessions — depth, breadth and duration. Just because a recession might occur, it may not necessarily mean it will be severe,” the newsletter stated.
Since the economy has remained overheated for several months, a recession could be seen as a possible correction period — with trade-offs between inflation and unemployment — before the economy returns to its normal state.
A mild recession
The CBC recently predicted that the economy would slow to a near stall during either the first or second quarter of 2023, affecting consumers and businesses alike. Yet, it believes households should make it through “relatively unscathed” since aggregate household savings should soften the blow.
There are downsides to the forecast, however, because if the Russia-Ukraine war escalates, the global economy could face a major downturn, the newsletter continued. Moreover, if inflation “becomes sticky,” households will have to endure a prolonged — but short-term — period of high prices, further dampening consumer confidence and spending.
The CBC’s forecast represents the performance of the entire economy over the medium term and considers future changes in monetary and fiscal policy, it added.
Conversely, its recession tracker assesses the risk of such an event in the next 12 months using current financial and macroeconomic indicators — and therefore is not considered a forecast.
