Stagnated Growth: A Canada Macroeconomic Update

With inflation remaining consistent during the year, the economy remained pressured. While consumption grew partly due to the holiday season, inflation continued to be a pressure point in the economy, resulting in numerous interest rate hikes and tempering overall growth. In turn, Canada's real GDP stagnated in the fourth quarter of 2022. In lieu of recession fears, there's a trend of positive employment and wage developments. The recent pause in interest rate hikes in March 2023 also signals economic alleviation for consumers and investors.

Labor market

• The second half of 2022 kept the unemployment rate near a record low due to an increased overall population and strong labor participation growth, which concerns the Bank of Canada about an overheated economy. In February 2023, the unemployment rate stagnated at 5.0%, reflecting a marginal gain from the start of the second half of 2022.
• Employment growth at the start of 2023 was driven by health care and social assistance, public administration and utilities. While growth exceeded expectations in January, overall employment displayed little change, rising just 0.1% in February.
• The average hourly wage, measured in current dollars, continued its strong growth trajectory in 2022, increasing 2.7% in the year's second half. Growth continued in 2023, reaching $33.13 in February.
• As the second half of the year exceeded expectations, the Bank of Canada debated raising interest rates at the start of 2023, citing a tight labor market as the Canadian economy reached full employment.

Consumer spending

• Household consumption expenditure (HCE) in Canada continued to expand in the fourth quarter of 2022, with consumer spending higher than pre-pandemic. Overall, HCE in the second half of 2022 is up 9.0% relative to the previous year and up 8.9% year-over-year.
• Increased consumption trends during the fourth quarter were led by a 4.4% increase in spending on transport, a 2.3% increase in spending on health and a 2.2% increase in food, beverage and accommodation services in the fourth quarter of 2022 compared with the third quarter of 2022.
• While HCE grew in the quarter, spending on furnishings, household equipment and other goods and services related to the dwelling and property stagnated. Rising food and housing costs have caused consumers to spend more on these items, leaving less budget for big-ticket items such as furniture and carpets.

Inflation

• Inflation, measured through the consumer price index, including food and energy, increased 5.9% year-over-year as of January 2023, slightly decelerating from the previous month.
• The slowdown in inflation is driven by tempering gasoline prices, which increased 2.9% year-over-year as of January 2023, compared with 3.0% the prior month.
• Gas price growth was tempered in the second half of the year amid continued concerns of the global economy slowing down and challenged demand in energy-reliant sectors, such as residential construction.
• Rising crude oil production helped fight off price hikes while declines in some energy-reliant sectors such as residential construction kept demand pressured.
• Conversely, the price of food increased 10.4% year-over-year as of January 2023, representing a 1.7% month-over-month increase.
• Since energy and food prices are volatile, inflation is also measured excluding these items. Inflation excluding food and energy was up 4.9% year-over-year in January 2023.

Construction: Canada

• As the inflationary environment grows, interest rates have risen in response, challenging construction activity.
• Construction activity continued to climb in the third quarter as interest rates earlier in the period did not start rising to record levels until July 2022, when the Bank of Canada (BoC) announced a 100-basis point (bp) interest rate hike. This rate hike gradually slowed down construction activity in August 2022, eventually leading to straight declines from September to the end of the year.
• As monetary tightening is expected to continue, interest rates will stabilize to help curb inflation.
• Nonresidential construction grew as projects approved earlier in the year started, curbing the pressure from residential construction declines.
• The Strategic Innovation Fund helped boost the development of more value-added construction projects. Some of the projects announced in the period were the expansion of Nokia's Ottawa production plant and the construction of the E3 Lithium production plant.

Construction: Ontario

• As Ontario remains one of Canada's most populated regions, total construction declined in line with the broader construction market. Over the six months through the end of December 2022, total construction fell 4.8% compared to the overall 11.5% construction decline in the country.
• Marked by higher interest rates and rising construction costs, investments in Ontario's residential construction declined 10.7% in the six months. However, in the same period, nonresidential investments grew 13.6%, boosted by a steady influx of economic activity in the region. Nearly 53.0% of enterprises based in the region are expected to expand their operations, according to the 2022 Ontario Economic Report.

Financial markets

• Bank of Canada continues rate hikes, with the overnight rate at 4.5% and a Bank Rate of 4.75%. Per their target inflation of 2%, BoC is holding their quantitative tightening policy stance, resulting in a 75 basis point hike in September and 50 basis point increases in October and December. 2023 started with a 25 basis point increase in January and no change in March.
• In response to the COVID-19 (coronavirus) pandemic, BoC began an asset purchasing program to have sufficient credit for consumers and businesses. Due to sustained inflation, asset purchases stopped in March 2022. To assist in quantitative tightening, BoC began selling assets, such as bonds, to reduce the money supply in the economy. There is no indication of purchasing assets soon.
• As inflationary concerns continue to weigh on the economy, the S&P/TSX returned an 8.7% fall year-to-date. As with the year's first half, healthcare remains the worst-performing sector, plummeting 57.7% in the fourth quarter. At the same time, the most significant declines occurred in the Information and Technology sector as consumer confidence in the economy remains challenged by continuing inflation. However, energy was the best-performing sector in the period, growing 48.4% YTD.

Distribution of risk ratings

• Risk in 2020 was elevated due to the onset of the pandemic, resulting in 64.0% of industries rated as a medium-high or greater risk.
• 2021 risk levels moderated despite new variants and ongoing supply chain disruptions, with 37.6% of industries rated as a medium-high or greater risk.
• In 2022, risk levels eased further to just 32.7% of industries rated as a medium-high or greater risk, driven by a reopening economy.
• Despite improvement since the onset of the pandemic, recent elevated inflation is expected to drive up inflation in 2023 and 2024. Consequently, 45.5% of industries are rated as a medium-high or greater risk in 2023, and 51.7% are rated as a medium-high or greater risk in 2024.

Macro outlook

As inflation has remained elevated as HCE continued to expand, the economy responded by stagnating in the fourth quarter of 2022. The Bank of Canada hiked interest rates to combat inflation, tempering overall spending. While these trends did not result in overall declines in the economy in Canada, raised concerns regarding inflation and a looming recession have intensified. As the Bank of Canada's pause on interest rate hikes signals some recovery in the outlook, these rates remain subject to change as the US Federal Reserve has continued to raise rates.

As the Russian invasion of Ukraine has continued to weigh on oil prices and other commodities, many countries decoupled from Russia as an energy source, bolstering Canada's energy production. However, the added pressure from a wider berth of consumers investing in the economy pressured producers to increase their output, fueling the year's inflated gas and oil prices. With no signs of an immediate recovery in inflation, commodity prices are set to remain elevated. However, as domestic producers have increased their output in the period, these prices may shrink from the previous year when the world responded to the war more immediately, with prices further eased by recession concerns. However, Canadian companies have a competitive advantage in the energy and commodity sectors, as agriculture continues to benefit from its trade balance, corporate profits, job creation and the strength of its dollar.

Sector highlights

Construction

Higher interest rates have challenged the construction market. In particular, mortgage rates and home prices drive house purchases, which have a bearing on the number of housing starts. Due to elevated interest rates, residential construction investments have slowly declined in the period. In contrast, nonresidential construction investments have expanded amid growing consumer activity and public incentives. Amid a recent pause of interest rates as of March 2023 and increasing immigration rates in 2022, demand for residential housing is set to grow in the period, aiding growth in the Apartment & Condominium Construction industry.

Finance and Insurance

As interest rates have increased to combat inflationary pressures, borrowing costs have grown. Despite being revenue-generating for banks that lend money to consumers, it may temper future growth as more consumers pull back on investing and spending in favor of saving more and investing less. While the likelihood of a recession remains high in 2023, this sector is set to benefit from the recent pause in rate hikes, boosting demand for loans affected by interest rates, such as mortgages and auto loans from consumers. However, rates are subject to change amid the latest volatility pending on the rate of recovery in the economy. Canada's Commercial Banking and Loan Administration, Cheque Cashing & Other Services industries are set to benefit from these current trends.

Mining

In response to international markets decoupling reliance on Russian energy, domestic energy production has steadily grown to meet demand from domestic and international consumers. In turn, Canadian oil prices have shrunk marginally over the second half of 2022 as increased supply from increased production helped offset these demand levels in the latter half of the year. Increasing clean energy production in Canada and internationally is expected to pressure oil prices as Canadian producers operate in a more competitive environment. The US Energy Information Administration expects Brent oil prices to reach $83.00 by the end of 2023, lower than previous year highs. However, domestic demand in Canada will prevent straight declines, especially with a higher population and increased investments in the industry, keeping the Oil & Gas Extraction industry elevated at a more competitive rate.