Canada

Like most developed countries, Canada’s economy rapidly recovered from the Covid-19 shutdowns with the help of generous monetary and fiscal stimulus. The economy gave a very good performance in 2021, which continued into 2022, driven by the consumer and the manufacturing sector. While the stimulus programs of 2020 and 2021 clearly powered the economy ahead, there are also costs associated with those programs that will weigh on the Canadian economy in 2023.

Indeed, leading indicators at the end of 2022 were pessimistic. The Bank of Canada’s (BoC) Business Outlook survey had been weakening for four quarters and was approaching negative territory. Respondents to the survey said the outlook for future sales was clearly negative, indicating that sales over the next year would be lower than the current year, which is almost the definition of a recession. The Canadian Federation of Independent Business's (CFIB) Business Barometer survey had been sliding all year and was hovering just above negative territory. The Ivey Purchasing Manager’s Index (PMI) had also been in decline for months and was headed into contractionary territory.

There is no doubt these negative outlooks have been caused by the actions of the BoC. When the Covid-19 lockdowns occurred, the BoC responded by imposing emergency conditions, setting the overnight policy rate to essentially 0%, and exploding the balance sheet with virtual money printing, making enormous amounts of liquidity and credit available. While it was the right thing to do at the time, it was a set of policies that was kept in place much longer than was needed (arguably a year too long). And it was the perfect formula for inflation – too much easy money for too long. As a result, inflation exploded into the economy.

Thinking that supply-chain delays and labor shortages had been the primary source of inflation, the BoC was caught off-guard and started the fight against inflation far too late. And since it takes three to five quarters for changes in monetary policy to take full effect, the Bank has had to be very aggressive in its rate hikes. Towards the end of 2022, the Bank had raised the overnight rate by 3.5% to 3.75%, the fastest pace in at least 30 years. In addition, it had also dried up about one quarter of the liquidity off of its balance sheet.

While the tightening to date will clearly affect the economy in 2023, even more tightening is in the works. The BoC’s actions will kill inflation, but will also likely drive the economy into at least two quarters of negative GDP growth in 2023. In fact, the BoC’s rate hikes have already sent the yield curve (the difference between the 10-year and 2-year benchmark government interest rates) into the deepest inversion since 1990, a very strong signal of an impending recession.