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Canada facing deeper recession as interest rates take hold: Deloitte

Bank of Canada's interest rate hikes are slowing economic growth

The Bank of Canada has appointed Nicolas Vincent, an economics professor at HEC Montreal, as a non-executive deputy governor for a two-year term. The Bank of Canada building is pictured in Ottawa on Tuesday, Dec. 6, 2022. THE CANADIAN PRESS/Sean Kilpatrick
Deloitte Canada's latest Economic Outlook, released on Tuesday, says that the impact of rising interest rates and a slowing U.S. economy will drag down economic growth. (THE CANADIAN PRESS/Sean Kilpatrick)

Canada will enter a deeper recession than previously expected this year as the Bank of Canada's rapid interest rate hikes take hold and the U.S. economy enters a slowdown, according to a new report from Deloitte Canada.

Deloitte Canada's latest Economic Outlook, released on Tuesday, says that the impact of rising interest rates and a slowing U.S. economy will drag down economic growth in Canada for three consecutive quarters, resulting in a 0.9 per cent contraction in GDP growth in 2023.

"It's fair to say that 2023 is shaping to be a rocky year for the Canadian economy," Deloitte Canada's National Economic Advisory Leader Trevin Stratton said in an interview with Yahoo Finance Canada.

"While we were previously projecting a recession in the fall of last year, the conditions have worsened a bit and so we're projecting a slightly longer recession now."

Deloitte had previously forecast in September that Canada would enter a short-lived recession, with growth stalling in the first quarter of 2023 before returning to positive territory in the second quarter of the year. At the time the forecast was released, the Bank of Canada had hiked its benchmark interest rate by 300 basis points.

But the central bank wasn't done in its effort to crackdown on inflation, and it raised the benchmark rate an additional 100 basis points, bringing the overnight rate to its current position of 4.25 per cent. Interest payments on household debt in Canada have since soared, increasing by 16.2 per cent on annual basis in the third quarter of the year, the largest increase on record. That, along with slowing economic growth in the U.S., "will hit Canada hard", the Deloitte report said.

"Households are being battered by the double whammy of high inflation and rising borrowing costs," the report said.

"Given the increase in interest payments, it’s not terribly surprising that real household spending fell in the third quarter. Unfortunately, interest payments are set to continue to increase over the coming year, squeezing household budgets and leading to yet more declines in consumer spending."

Consumer spending has already dropped off, but the declines will not be felt equally across all categories. Deloitte said goods sensitive to interest rates, such as household furnishings and appliances, will be hit hardest, and that discretionary spending on services such as communication, recreation, accommodation and food will also decline.

Deloitte now expects real GDP growth to fall in the first and second quarters of the year, with zero growth predicted for the third quarter this year.

Still, the report noted that one of the "wild cards" in the forecast is the Canadian labour market, which has remained tight despite concerns about an economic slowdown. Stratton said while recessions traditionally are associated with significant job losses, the current situation is different as businesses need to balance softening demand against a tight labour market.

"Given these type of conditions, we actually don't expect employment to decline overall. Employers are somewhat reluctant to let go of workers, for fear of not being able to fill vacant positions once the economy begins to recover next year," Stratton said.

"That's not to say there's good news across the board. Job losses are expected in certain sectors... including in construction, wholesale and retail trade, transportations, the arts, amongst others. But in spite of those losses, we are forecasting that the current labour market is providing support for the economy and preventing the downturn from being worse."

While Stratton noted that the forecast "may sound dire," the recession will be relatively mild compared to the Great Recession in 2008 and the pandemic-induced slowdown in 2020.

"We are expecting inflation to decelerate in response to the contraction of the economy, and this is going to allow the Bank of Canada to reducing interest rates before the end of the year," Stratton said. Deloitte expects the Bank of Canada will cut rates throughout 2024, which will allow for a modest economic recovery.

"But we're going to see significant economic headwinds in the next six to nine months, and this is going to be challenging for many Canadians."

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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