Resilient economy may muddle inflation fight, recession still expected: economists

Pedestrians walking in the financial district of Toronto. Photo by Brent Lewin/Bloomberg files

TORONTO — Canadian households and the overall economy have proven surprisingly resilient in the face of rising interest rates, said senior economists from the big banks, which could complicate the fight against inflation.

“There’s no question that the economy had much more momentum at the end of last year than really anyone was expecting,” said BMO chief economist Douglas Porter, speaking at an Economic Club of Canada panel Friday about the outlook for the year ahead.

His comments come as data out last week showed the economy added a surprise 104,000 jobs in December, while delinquencies on mortgage payments remain around historic lows.

Porter said however that history shows a recession has been unavoidable after rates rise this fast, and that the resilience could make for a tougher fight ahead against inflation.

“The reality is if the economy remains too strong, then rates will go even higher.”

While there is the risk of needing higher rates to cool the economy, there is the potential for the resilience shown so far to lead to the gentle cooling that policymakers are attempting, said Scotiabank chief economist Jean-Francois Perrault.

“It’s a worrisome thing in the sense that maybe it means you do have higher rates,” said Perrault. “The flip side of that is maybe this Holy Grail of a soft landing is no longer mythical, that we might actually engineer that.”TD chief economist Beata Caranci said the health of the economy, along with the fact that many industries like manufacturing are still pretty lean on hiring trends, means that a recession will likely mean far fewer job losses than usual.

“We have about 100,000 job losses occurring this year, which will not be mild or that 100,000 and their family, if it occurs. However, that is a third of what would normally occur in a recession.”

There’s still a lot of pain to come

Craig Wright

RBC chief economist Craig Wright said the bank is sticking to its forecast of a recession that it’s been predicting since last July, as a number of long-term tailwinds including free trade, cheap credit and low-cost labour, reverse.

He noted the effects of the rapid rate increases still haven’t played out because of the lag on how long it takes to hit the economy.“So there’s still a lot of pain to come.”

Wright however expects the slowdown, purposefully imposed through interest rates, will do its job and have inflation back to the Bank of Canada’s target range of one to three per cent by the end of the year.

Others aren’t so confident inflation will be able to come down so quickly, with Porter noting that underlying inflation, which strips out some volatile prices like energy, looks to be settling in at around five per cent and it will be tough to get that down as expectations shift.

“That’s what’s going to be the tougher nut to crack here. It was relatively easy getting inflation down from eight to six or as gasoline prices retreated, but it’s that next step back down to two per cent that I think is going to be a little bit more of a challenge.”Caranci also noted that emerging factors, like the reopening of the Chinese economy, could also push energy prices back up, with the bank forecasting oil going back up to US$90 a barrel, which would further complicate the inflation fight.

Overall, it will be some time before economists know how well the sharp rise in interest rates are working, and how it will play out in households and the overall economy.

“Monetary policy takes a long time to have an impact,” said Perrault. “You increase it a lot, and then you got to wait to see if it works or not. And that’s the challenge that we have, and they have.”

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