Canada’s economy is beating expectations, but for how long?

The economy has proven more resilient than expected in 2023. In both the U.S. and Canada, GDP continued to grow in Q1 as consumer spending held despite higher interest rates and prices. Low unemployment rates have persisted, and inflation is still running above central bank target rates. Concerns about the U.S. regional banking sector have calmed down, at least for now, and the next fight over the U.S. debt limit has been kicked down the road to after the 2024 elections.

The war in Ukraine continues, but energy costs have fallen back, and global supply chain pressures have further eased. China’s economic growth is slowing, but by now this should be expected as demographic headwinds from an aging population build.

Overheating labour market conditions and a large stockpile of household pandemic savings in Canada might delay the full impact of tighter monetary policy. But the surge in interest rates over the last year will continue to take a toll. Higher prices and interest rates already ate up all of the increase in Canadian household after-tax wage incomes in 2022. And they look on track to do so again in 2023. We continue to think the most likely base case outlook includes at least ‘mild’ recessions in Canada and the United States—although we now expect declines in GDP to start a quarter later (Q3 and Q4 2023) than previously expected.

Strong data today could delay but won’t prevent a ‘bumpy’ landing

The return of inflation to central bank target rates (2%) is still contingent on a softening economy. If recent momentum continues to surprise on the upside, then the Bank of Canada and other central banks will need to hike interest rates more than expected. The Bank of Canada already ended the pause in interest rate hikes that started in January this year with a 25-basis point hike in June. We don’t think the U.S. Fed will follow suit for its meeting next week given earlier communications. We do however expect both central banks to move key policy rates higher again by 25 bp in July, unless economic data deteriorates more than expected before then. The only true ‘soft landing’ scenario is one where inflation pressures slow quickly back to target rates without a deterioration in the economy, and that still looks unlikely.

So even near-term positive growth surprises will only delay, rather than prevent, a ‘bumpy’ landing. Even as higher prices and interest rates soak up a larger share of purchasing power, consumers in Canada continue to spend. Housing markets look like they’re past their bottom with home resales and prices rebounding in the spring, and the ratio of demand to available listings shifting in favour of sellers in arising share of markets. Our own tracking of card data showed spending on necessities and other discretionary goods flattening out. On the other hand, spending on local entertainment like dining out has remained very firm.

Cracks are forming under the surface

Still, although unemployment rates are exceptionally low, there are signs that labour demand is weakening. Job openings are down almost 20% from peak levels in Canada, and by 16% in the U.S. Fewer workers are quitting their jobs—normally a sign that confidence in labour markets is fading.

The impact of interest rate hikes since early 2022 has yet to fully flow through to borrowing costs. But consumer delinquency rates are already rising. And with average mortgage interest costs running almost 30% above year ago levels in Canada, we expect more softness to show up as these loans are gradually renewed at higher rates. In Canada, the debt servicing ratio—or the share of household disposable income eaten up by debt payments—will likely rise to record levels over the second half of this year.

Tighter credit markets adding to rate headwinds

Although concerns about the U.S. regional banking sector have subsided, banks are still broadly reporting tighter lending conditions. Canadian credit markets have been more stable this year but have also seen lending conditions tighten.

Persistent labour shortages mean businesses will be slower than usual to forego productivity-enhancing investments, but we still expect some softening in this arena going forward. In the U.S., where lending conditions have tightened more significantly, growth in factory shipments has slowed, commercial and industrial loans have started to edge lower.

Price pressures to continue to ease, but more slowly for services

Lower energy costs are pushing headline inflation rates lower both at home and abroad. As of May, gas prices in Canada were still high but running almost 20% below year-ago levels. Home heating costs have also fallen sharply (just in time for summer) with natural gas and fuel oil costs also down from a year ago when Russia’s invasion of Ukraine sent energy costs soaring.

Food price growth remains high but appears to be past its peak. The surge in grocery prices over the last year was driven by a combination of choked supply chains, soaring transportation and labour costs, and higher agriculture commodity prices. All of these factors have now eased. Global shipping costs have plunged and local transportation (road and rail) costs are increasing more slowly. Agriculture food commodity prices are down 15% from their 2022 peak, leaving them closer to levels last seen in summer 2021.

Though broader inflation pressures have also eased, they’re still too firm for central banks to relax. The BoC’s preferred core measures have been running at around a 3 ½% annualized rate—still above the top end of the 1% to 3% target range.

Immigration will prevent a crash, but not a decline

In Canada, surging population growth is helping to fill more jobs. The unemployment rate hasn’t budged in 2023 from the exceptionally low 5.0% at the end of 2022. And employment increased by a quarter of a million over the first four months of 2023. That’s boosting economy-wide output, providing higher wage and salary income to help offset rising debt and inflation costs.

Structurally higher population growth makes it tougher for the economy to contract by adding to overall consumption. That’s particularly true in housing markets, where it’s tougher for new supply to respond quickly to surging demand. We still expect the impact on household purchasing power from higher prices and interest rates to ultimately push GDP lower, but strong underlying population growth makes it more likely that downturn will be ‘mild.’

Provincial Outlook

Despite a relatively strong start to the year, we expect cooler winds to moderate growth in all but one province (Newfoundland & Labrador). While slumped investment is likely to keep economic growth in B.C. (+0.6%) and Quebec (+0.6%) constrained this year, a lagging oil and gas sector in Newfoundland & Labrador (+0.7%) and soft consumer spending in Ontario (+1.1%) will keep these provinces growing—though behind the Canadian average (+1.3%). Though they’ve moderated from their 2022 highs, strong commodity markets are poised to keep Canada’s Prairie provinces at the top of this year’s growth ranking—with Alberta taking the lead (+2.4%), followed by Saskatchewan (+2.0%) and Manitoba (+1.9%). Above trend population growth out east will continue to support a vibrant labour market and strong spending—keeping real GDP growth in P.E.I. (+1.7%), Nova Scotia (+1.5%), and New Brunswick (+1.4%) in the middle of the pack.

BRITISH COLUMBIA – Hitting a soft patch

It will take more than a rebound in the housing market to prevent B.C.’s economy from softening significantly this year. Large capital projects that fueled tremendous activity in recent years are now past their peak or winding down, cooling the construction sector. Higher interest rates still weigh on B.C. consumers—the most indebted in the country. In fact, increased financial pressures have already started to weigh on consumer spending since the fall. We expect headwinds to be stronger in B.C. than in most parts of the country, sending the province to the back of our growth ranking this year. We expect real GDP in B.C. to expand by just 0.6% in 2023—down from the 3.6% rate of growth recorded last year.

ALBERTA – Taking the lead

Alberta’s economy is on a roll. Last year, it grew at the second-fastest pace (+5.1%) in the country, and the start of 2023 looks no different. The province’s key energy sector is maintaining strong momentum (despite some disruptions caused by wildfires), job creation remains solid, the population is booming, and consumers have yet to let up. While we expect growth to moderate over the remainder of this year, the weight of higher interest rates isn’t likely to have the same impact on Alberta’s economy as other provinces. We expect Alberta to lead our 2023 growth ranking with a rate of 2.4%. The spring’s massive forest fires, however, pose a downside risk.

SASKATCHEWAN – Stronger investment keeps economic wheels turning

Saskatchewan’s economy is back on its feet. It outgrew all other provinces in 2022—after a two year-long slump—and it continues to show signs of vigour so far this year. Robust commodity markets—and promising longer-term prospects for them—are attracting large investments in mining, which fuels substantial spinoff activity in other sectors. But the province won’t be immune to the broader cooling in the national and global economies. After a sharp increase last year, the near-term outlook for mining production has dimmed. Commodity prices have come off cyclical highs, prompting provincial producers to trim output. Indeed, mineral production is down 10% from year-ago levels. We believe this will be a temporary adjustment. As such, we forecast growth to slow significantly to 2.0% this year from a near decade-high of 5.7% in 2022. This would still place Saskatchewan near the top of our 2023 growth ranking.

MANITOBA – Stiffer headwinds on the horizon

A strong upturn in the agricultural and manufacturing sectors is fueling a surge in Manitoba’s exports. Key domestically-oriented sectors also continue to run hot thanks to pent-up consumer demand and solid non-residential construction activity. These have more than offset a slump in residential investment for now. But we believe that offset will get slimmer as external and domestic demand cools. We forecast provincial economic growth to slow from 3.9% in 2022 to 1.9% this year—ahead of the national average of 1.3% for a second-straight year.

ONTARIO – Economy set to lose steam

Ontario’s economy built quite a head of steam in the past couple of years, which continued to power growth in the early months of 2023. Higher interest rates did cool the housing market dramatically and dampen consumer spending, but their broader impact has yet to be felt. We think that’s about to change. We expect stiffer debt service costs to curb demand for Ontario goods and services both at home and abroad over the remainder of this year. Overall, we expect growth to moderate significantly to 1.1% in 2023 from 3.6% in 2022.

QUEBEC –  Stagnation to set in

The near-term outlook is neither cheerful nor grim in Quebec. Instead, we think the provincial economy has entered a period of stagnation that may include a slight contraction later this year. Slumping residential investment and moderating activity in the manufacturing and resource sectors have already slowed momentum since the middle of 2022. Services industries will be the next ones to get caught in the headwinds. Some of these services (e.g. professional and technical services, and healthcare) may have plateaued earlier this year. We project minimal growth of 0.6% overall in 2023, marking a sharp easing from the solid 6.0% and 2.6% advances recorded in the past two years, respectively.

NEW BRUNSWICK – Facing domestic and external challenges

Economic growth decelerated markedly last year to 1.8% from 5.9% in 2021, dragged by declines in the manufacturing sector and key service industries. We see scope for further modest deceleration in 2023 as consumers at home and abroad come under increasing pressure. We forecast the provincial economy to grow by 1.4% this year.

NOVA SCOTIA – Wave of newcomers to buffer the economy

Although Nova Scotia’s economy last year grew at half its (frantic) pace in 2021, the performance could hardly be called weak. The 2.6% rate achieved still far exceeded the average 1.9% in the five years prior to the pandemic. Record levels of in-migration did wonders for consumer spending and residential investment—and got the province’s labour market in better shape. But while favourable demographic trends will continue to boost the provincial economy this year, we expect a cooling global economy and higher interest rates to prove more challenging. We project growth to moderate further to 1.5%—still outside recession territory—amid weakening demand for exports and domestic goods and services.

P.E.I. – Population boom continues

For the first time since 2018, P.E.I.’s growth rate lagged the national average last year at 2.9%. Downturns in the construction, fishing and wholesale industries, as well as slower growth in the agricultural and healthcare sectors held back the economy’s pace. But it wasn’t a weak outcome by any means. Following the 2021 surge, P.E.I. is finally seeing a return to the average rate seen in the five years prior to the pandemic. Record in-migration has helped support solid job creation and keep consumers in a spending mood. We expect recessionary conditions in North America to further moderate real GDP growth on P.E.I. this year to 1.7%.

NEWFOUNDLAND & LABRADOR – More setbacks in 2023

Newfoundland & Labrador was the only provincial economy that contracted in 2022 as the energy sector declined for a second consecutive year. Recent developments in the province’s key industries suggest Newfoundland & Labrador may be in for a softer year in 2023 than we previously anticipated. A dimmer outlook for oil production, in particular, now casts a shadow over the recovery from last year’s decline in activity. As such, we have downgraded our growth projection for this year to 0.7% from our prior forecast of 1.6%.

Detailed forecast tables:

As RBC Chief Economist, Craig Wright leads a team of economists providing economic, fixed income and foreign exchange research to RBC clients. Craig is a regular contributor to a number of RBC publications and is a key player in delivering economic analysis to clients and the media through the Economics Department’s regular economic briefings.

Nathan Janzen is an Assistant Chief Economist, leading the macroeconomic analysis group. His focus is on analysis and forecasting macroeconomic developments in Canada and the United States.

Robert Hogue is responsible for providing analysis and forecasts on the Canadian housing market and provincial economies.

Claire Fan is an economist at RBC. She focuses on macroeconomic analysis and is responsible for projecting key indicators including GDP, employment and inflation for Canada and the US.

Rachel Battaglia is an economist at RBC. She is a member of the Macro and Regional Analysis Group, providing analysis for the provincial macroeconomic outlook.

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