Economists at Desjardins are predicting that Canada will enter a mild recession in the first half of 2023, as aggressive interest rate hikes, a cooling housing market and weak growth in the United States drag on the country's economic outlook.
In a report released Thursday, Desjardins economists said bringing soaring inflation back to a 2 per cent range "won't be easy" and a soft landing – where inflation is tamed without leading to a recession – has become "increasingly unlikely."
"Canada's economy, like so many others, seems to be entering a slight downturn that should reach its nadir in early 2023. In our opinion, this decline is a necessary evil and will help offset some of the imbalances that are feeding inflation," chief economist Jimmy Jean, senior director of Canadian economics Randall Bartless and principal economist Hendrix Vachon wrote in the research note.
"We now expect the Canadian economy to tip into a mild recession in the first half of 2023."
While Canadian inflation slowed to 7.6 per cent in July, the Bank of Canada has signalled continued interest rate hikes are necessary to tame soaring inflation. The central bank has been hiking rates aggressively since March, with its most recent 100 basis point hike bringing its key interest rate to 2.5 per cent.
The benchmark interest rate is expected to reach at least 3.25 per cent this fall, which the Desjardins economists noted will put further pressure on the Canadian real estate market and weigh on household spending and business investment, leading to a slight contraction in real GDP in early 2023.
But the most significant factor weighing on growth will be a cooling housing market. Since hitting a peak in February, home sales have fallen 31 per cent nationally and prices have dropped 17 per cent, the economists noted. Jean says in a separate note to clients that the housing market correction and spillovers to domestic demand will be enough to orchestrate two consecutive quarters of GDP contraction at the start of next year.
"We expect the housing market to continue to cool for several more quarters, which should pull down residential investment through the end of 2023," they wrote.
"This will act as the main drag on the Canadian outlook."
With growth slowing, the economists warned that the job market will weaken and likely push up the unemployment rate. However, they also noted that with the job market starting from a position of strength and with record high labour shortages, the unemployment rate could rise less than predicted. Higher savings rates among Canadian households may also result in fewer households struggling financially.
Still, the economists noted that the soft-landing scenario is less realistic than a "short and shallow" recession, but that "failure to respond to high inflation would be even more detrimental for economic growth in the long term."
"Inflation hurts everyone, but particularly the most vulnerable. It destroys purchasing power, and many Canadians don't see their income keep up with their expenses. Inflation also adds uncertainty to financial markets and discourages investment," they wrote.
"A recession in 2023 might not be good news, but it should help stave off an even more painful outcome. It is also likely to lay the groundwork for stronger growth in 2024, accompanied by lower and more stable inflation."
Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.