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Get ready for an economically challenging 2023

Jock FinlaysonFor economic prognosticators, the year that just ended threw up some big surprises, including the first land war in Europe since 1945, spiralling inflation, and a series of rapid-fire interest rate increases as panicked central bankers rushed to tame soaring prices.

Few, if any, forecasters anticipated these developments – a stark reminder of how hard it can be to predict where the economy is headed.

The good news is that overall economic output (gross domestic product, or GDP) and employment in Canada have more than fully rebounded from the brief COVID-induced recession of 2020. Indeed, for at least the past year, Canada’s economy has been operating above potential, meaning demand has exceeded supply.

This has fed an alarming jump in inflation and aggravated widespread labour shortages. Spendthrift governments are part of the inflation story: both the Trudeau government and several provinces have continued to throw large dollops of money at an economy that no longer needs any “fiscal stimulus.”

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Economic momentum recently has been flagging amid slower global growth, rising interest rates and tumbling housing markets. The weakness is set to intensify into 2023. Canada will struggle to crank out positive economic growth this year. While we may avoid a technical recession (defined as two consecutive quarters of declining GDP), mainly owing to a fast-growing population, at best Canada is set for a “slowcession” as economic activity basically grinds to a halt.

Higher interest rates and steeper borrowing costs are the main reasons for the economic downturn. Both the Bank of Canada and the U.S. Federal Reserve look to be close to finishing their policy tightening after a flurry of interest rate hikes starting last March. But because monetary policy works with a lag, the economic pain from last year’s soaring interest rates will be felt over the next year or more.

What about inflation?

On average, the all-items Consumer Price Index (CPI) was up by 6.8 percent last year, more than triple the Bank of Canada’s official two percent target. Most Canadian forecasters believe inflation will retreat, albeit gradually, toward an annualized rate of 2.5 to three percent by the end of 2023. This reflects the impact of sagging housing markets, muted consumer spending, sluggish global growth, and further improvements in manufacturing supply chains that were disrupted by the pandemic.

As the economy cools and inflation diminishes, the Bank of Canada will ease its policy stance, with interest rates likely to decline toward the end of the year. But Canadians should not expect mortgage and other borrowing costs to drop all the way back to the record low levels seen in 2021.

As for the financial markets, investors will be relieved to see the back of 2022. Stocks sold off savagely last year, while fixed income markets (where bonds are traded) posted their worst performance in centuries, crushed by a toxic mix of high inflation and escalating interest rates. Globally, the combined value of publicly traded securities plunged by an estimated U.S.$30 trillion in 2022. The coming year should bring some recovery in North American stock and bond markets.

With a global recession at the doorstep and the domestic economy losing steam, Canadians should prepare for a challenging 2023. At this point, the most likely scenario is a brief and shallow recession over the first half of the year before economic activity picks up toward the end of 2023. Risks to the outlook are tilted to the downside: they include how the Russia-Ukraine war unfolds in the coming months, the extent and duration of the looming U.S. economic downturn, and the impact of higher interest rates on heavily indebted Canadian households.

Jock Finlayson is Senior Policy Advisor with the Business Council of B.C. and a Senior Fellow with the Fraser Institute.

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