Inflation Stays: A Canada Macroeconomic Update

Canada’s economy remained pressured in the second half of 2023, as inflation continued to influence many downstream industries. Despite this, consumer spending remained buoyant in the second half of the year, though inflation data cooled down from concerning levels reached during the COVID-19 pandemic and in the years that immediately followed. Interest rates were stuck at July 2023 levels for the remainder of the year, which somewhat relieved fears of more hikes in the year. However, unemployment rates scaled up in 2023 amid the dismal performances of some sectors. At the same time, construction activity narrowed in the second half of the year due to mounting costs and elevated mortgage rates.

In spite of these factors, real GDP growth went up 0.2% in the last quarter of 2023, slightly fending off worries of an economic downturn – but a 0.1% drop in real GDP for Q3 2023 also suggested that pressures from inflation remained a cause for concern.

Labor market

• In the second half of 2023, the unemployment rate climbed, reaching 5.8% in December. This indicated a worsening of the labor market in the second half of the year as factors like inflation raised costs for businesses, resulting in layoffs and companies adopting more conservative hiring practices.
• The results of population growth continued to have a compounding effect on the labor market. These pressures created an environment in which more people were searching for jobs while only a finite number of jobs were readily available, which prevented additional jobseekers from getting hired and ultimately left more people unemployed and looking for work.
• Employment moderated in the second half of 2023, scaling up by 0.8% with sectors like health care and social assistance and professional, scientific and technical services leading the way in terms of employment growth in the period. However, sectors like wholesale and retail trade and finance, insurance, real estate, rental and leasing endured the most job losses in the second half of the year.
• Average hourly wages, measured in current dollars, were up by 4.0% in December 2023 from June 2023. Companies made efforts to raise their wages perhaps in a bid to help retain their established talent while labor unions negotiated higher wages for their members. The Canadian government raising the minimum wage also played a role in employees getting paid more in the latter half of the year.

Consumer spending

• Household consumption expenditure (HCE) in Canada was not deterred heavily by inflationary pressures, being up 6.0% year-over-year in the fourth quarter of 2023. This measure went up within 2023 as well, rising 1.8% from the first half to the second half of the year.
• Education and housing, water, electricity, gas and other fuels led in terms of spending in the second half of the year. The essential services provided make these categories vital for consumers, and uniquely positioned to compel more spending. This, combined with their elevated costs in the same period due to inflationary pressures and decisions made by higher educational institutions to raise their tuitions amid buoyant popularity among various demographics, resulted in more spending in these areas.
• The categories of clothing and footwear and alcoholic beverages, tobacco and cannabis went down the most in terms of consumer spending in the second half of 2023, as these items remained expensive to purchase in the midst of an inflationary environment. This worked against their appeal in the period, especially as consumers had chosen to spend more on categories deemed essential and that might require regular, scheduled payments.
• Energy spending remained mixed in the defined period: gasoline spending went down by 6.8% while other fuels and electricity went up by 7.2% and 7.0%, respectively. Higher prices on electricity amid higher demand helped fuel more spending on this category, while boosted generation of renewable energy sources helped expand their presence in the period for consumers that were directly or indirectly using these sources in their day-to-day activities.

Inflation

• When measuring year-over-year inflation with the consumer price index, which includes both food and energy items, inflation rose 3.4% in December 2023. This signifies how stable inflation had been, as year-over-year inflation stayed below 4.0% in all months of the second half of the year.
• Housing and food prices both went up the most in December, rising by 6.0% and 5.0% year-over-year, respectively. Inflationary pressures on various inputs mixed with a disappointing crop year complicated food prices in 2023. As well, housing inventory remains pressured amid higher mortgage rates while homeowners contend with the effects that elevated prices on materials and equipment have had in the costs to maintain and repair a home. This changing residential landscape resulted in raised costs for shelter in the period.
• Household operations, furnishings and equipment trended down 1.7% in December 2023. These items had already been costly for some time, which discouraged consumers from buying more. Meanwhile, improvements made in the production of inputs that go into making these goods, like energy, helped scale down costs for this segment.
• Since energy and food prices are volatile, inflation is also measured without these items. When excluding these items, year-over-year inflation in December 2023 also went up by 3.4%, with no items going up exponentially in the month to keep both inflation measures at similar levels.

Construction: Canada

• Various challenges stemming from inflation and from interest rates having been settled at high levels in the period worked against construction activity in the second half of the year, with total residential and nonresidential construction investments falling by 2.8%.
• Despite a 10.2% surge in residential investments between June and December 2023, fewer transactions were made on homes, with a spike in five-year conventional mortgage rates constraining activity in the period. Mortgage rates, along with inflationary pressures, contributed to the national average home price downscaling during the period from $709,218 in June to $657,145 in December.
• Nonresidential projects experienced slight growth in the second half of the year, as investments went up by 0.5% from June to December. A large chunk of activity in this sector was directed toward industrial and retail projects, but a moderated slump in office and renewable projects also pressured investments made in this segment in the period.

Construction: Ontario

• Being the area with the largest population in the country, Ontario remained a hub for residential and nonresidential activity in the period. However, the second half of 2023 proved to be a challenge for the province, with a noticeable 5.3% drop in residential and nonresidential construction investments. This drop was slightly higher than that of the country as a whole in the same period.
• A seismic 9.0% boost in residential construction spending transpired in the period between June and December 2023, though year-over-year spending on these projects fell by 2.9% in December. Higher mortgage rates and inflationary pressures challenged the appeal of these projects.
• Spending on nonresidential projects slumped 2.1% between June and December 2023, though it went up by 5.2% year-over-year in December 2023. The country's economic activity and population concentration in the province helped expand investments for industrial and government projects.
• However, the region's commercial sectors endured challenges, as office projects had become a harder sell amid the popularity of work-from-home options. Meanwhile, the raised costs for borrowing and construction activity weakened this sector's appeal for investors grappling with potentially having to spend more for projects that may not be as value-generating for them in the midst of a more economically volatile period.

Financial markets

• The Bank of Canada (BoC) stayed its key interest rate, leaving it at 5.0% for much of the second half of the year except for July, where it did scale up by 25 basis points. The BoC made it clear that measures like inflation had not cooled down enough to justify a rate cut in the near term.
• In line with past decisions, the Bank of Canada has kept its quantitative tightening policies in place. This has, in turn, led to the Bank letting more bonds reach maturity and without resupplying its bond holdings to reflect these changes in its balance sheet. But the Bank also hinted it might roll back this policy beginning in 2025 as its balance sheet normalizes.
• Despite inflation and volatility in the economy, the S&P/TSX Composite Index returned an 8.1% year-over-year gain in the fourth quarter of 2023, led by a hefty 56.0% return in the information technology sector. The healthcare sector followed with a 22.1% return, along with a sizable 7.3% loss and a 4.3% loss in the communications services and utilities sectors, respectively.

Distribution of risk ratings

• With the pandemic still gripping the economy in 2021, risk levels remained elevated, with 47.3% of industries rated as medium-high or greater risk.
• Risk levels began to ease in 2022 amid some economic recovery alongside a resurgence in consumer spending and business activity, resulting in 38.1% of industries rated as medium-high or greater risk.
• 2023 brought economic challenges as soaring inflation stunted recovery through interest rate hikes and less discretionary spending, resulting in 54.1% of industries rated as medium-high or greater risk.
• The outlook in 2024 continues to pose some economic challenges and uncertainty as inflation remains high, with 54.5% of industries rated as medium-high or greater risk.

Macro outlook

Even amid inflationary concerns, consumer spending has been buoyant, signaling that the macroeconomic environment has steadily remained afloat despite worsening unemployment and elevated interest rates. However, inflation remains slightly above the 2.0% target rate, lowering the potential for an immediate rate cut. The Bank of Canada has committed to leaving rates where they are while inflation is elevated.

Despite these factors, the effects of quantitative tightening policies and pauses for interest rate hikes have instilled some confidence and raised hopes that inflation will eventually be curtailed. Yet the economy is lingering on an inflationary path with no signs of imminent slowdowns, as evidenced by prices continuing to go up. Prices are set to be a constraining factor on consumer spending and downstream activities like construction until the Bank of Canada’s goal can be realized.

Geopolitical headwinds like the Russia-Ukraine war remain a top concern, and the Canadian government has divested from Russia in protest of its actions. As a result, the government boosted domestic energy production to help fend off concerns that reduced trading with Russia will heavily impact energy prices. This being a set policy moving forward as the war continues will be a helpful factor in terms of spurring the domestic economy.

However, the escalation of tensions in the Red Sea in light of the Israel-Hamas war in late 2023 poses more risks for the domestic economy, especially for sectors that rely on goods transported from this area. While there are no immediate signs of Canada getting involved with a war in the near future, as the US and China continue to spar over trade and Taiwan, either of these issues could rope in Canada if matters escalate or potentially worsen into a geopolitical crisis. Were the BRICS+ nations economic group to get more involved, that might shake up Canada's trading activities as well.

Sector highlights

Mining

Despite a rebound in some energy sources in response to Russia's invasion of Ukraine in 2022, a divestment from unneeded and outdated energy sources remains a concern that has pressured mining sectors in the period. The escalating regulations imposed on coal, namely because of worries regarding its environmental impacts, have inhibited this sector in the period. This comes especially as Canada's largest trading partner, the US, has also begun to phase out this energy source in operations in favor of sources like renewables and electricity.

Like its largest trading partner, Canada has also started using more alternative fuels like solar energy to generate power, while making inroads to expand the presence of nuclear energy in the future. Meanwhile, the expanding appeal of zero-emission vehicles has cut into the market dominance of gas-powered automobiles. Gas production scaled up in the second half of 2023, but it remains uncertain to what extent traditional sources will remain the dominant market force as in the past, especially with the distribution of energy-generating innovations like solar panels and windmills cutting into this sector’s market share. With these various threats lingering in the background, Coal Mining and Oil & Gas Field Services are set to be more vulnerable in the outlook period.

Agriculture, Forestry, Fishing and Hunting

These industries have primarily benefited from Canada’s high degree of farming land to harvest crops and raise cattle. However, there are inherent weather-related risks in the country, as droughts, wildfires and extraordinary bouts of storms in the colder months present an issue for domestic farmlands that have to factor these volatile patterns into their operations.

Marked with competition from international rivals who fare better with weather, industries that are part of this sector have to operate under more pressures. These include challenges in attracting new talent compared with sectors that pay competitive salaries and that require fewer labor-intensive duties, which will test this industry's ability to expand in the years ahead. As such, industries like Corn Farming and Wheat Farming are set to endure threats in the outlook period.

Information

New developments in digital-only content and configurations to such developments via artificial intelligence have worked against this sector, which includes publishing and broadcasting and largely relies on more traditional approaches to delivering information to consumers. While revenue-generating, the reliance on subscription models is marred with challenges since consumers can read news or view entertainment from nonsubscription rivals that can present this same content at no cost to the user.

News and entertainment services have expanded on social media, for example. Outlets that are stuck presenting their content on their platforms, whether newspapers or magazines, will be limited while their digital rivals expand. For the years ahead, Newspaper Publishing and Magazine & Periodical Publishing are set to be increasingly threatened.