[Analyse] The interest rate shock is only just beginning

Heavily indebted Canadians are especially vulnerable to the current rise in interest rates. Ironically, the shock of the economic slowdown (already underway) will be even more severe if they adapt to it by reducing their lifestyles.

Economists used to say that the natural death for a period of economic growth is to fall under the blows of central banks and their interest rates. In fact, the tightening of their monetary policy has been one of the main factors responsible for 29 recessions in the G7 countries since 1960, compared with 19 for the bursting of a credit bubble or 13 for an oil price shock. of a real estate bubble, the SNB economists calculated.

And this time will be no exception, speakers said on Thursday at an economic conditions conference organized in Montreal by the Association of Economists of Quebec, speaking of the effect of the Bank of Canada’s soaring interest rates in its war on the ‘inflation.

At Desjardins Group, we have been predicting a “mild recession” in Canada for some time now. It would take the form of a modest economic contraction during the first half of 2023 and a slow return to square one during the second half of the year. At the same time, the average unemployment rate would rise from 5.4% this year to 6.5% next year.

However, the Canadian economy could count on the help provided by the global demand for oil and raw materials. Some also raise the possibility that the energy crisis caused by the invasion of Ukraine will cause some deindustrialization in Europe and benefit North American factories, noted Matthieu Arseneau, deputy chief economist at the National Bank.

For many, the labor shortage in recent months has “traumatized” businesses, which will hesitate before laying off employees. Matthieu Arseneau isn’t so sure. Also, as Canada’s population continues to grow, employers will only have to freeze their hiring to drive up unemployment, he points out.

Indebted families

At Desjardins, we still thought, until recently, that Quebec’s economy would remain within the Canadian average, benefiting in particular from a real estate market that hasn’t experienced the same excesses as the rest of Canada, as well as counting higher household savings Rate it.

But Quebec was already in a fourth monthly decline in its gross domestic product (GDP) in July, not seen since 2009, chief economist Jimmy Jean noted. As for consumer confidence, it is declining faster than elsewhere. Now we wonder if the recession won’t ultimately be stronger there than in the rest of the Canadian economy.

It should also be remembered that Canada is one of the countries with the most indebted households in the world, with a total debt equal to 107% of GDP, against 86% in the United Kingdom, 78% in the United States, 67% in Japan and 57% in Germany. This debt is due in particular to the sharp increase in the price of houses, which is also one of the highest in the world in relation to household disposable income. However, the accelerated rise in interest rates is not only severely dampening economic strength, but is also increasing households’ cost of borrowing as well as increasing the value of the homes on which their debts are based.

In his baseline scenario, Desjardins predicts that, faced with an economic slowdown, Canadian households will reduce their savings rate to what it was before the pandemic in order to maintain a certain level of consumption. However, if they choose instead to keep the same savings rate and offset even half of the increase in mortgage costs by cutting expenses, notes Jimmy, Jeans. We would then be faced with a situation uncomfortably similar to the long and painful recession of the early 1990s, namely a drop in consumption that would cause a 1.5% drop in GDP next year and an average unemployment rate which would drop from 5.4% to 7%.

delay effect

It is usually said that it takes 18 to 24 months for a change in monetary policy to have its full effect on the economy, recalls Sébastien McMahon, chief strategist at iA Financial Group. This means that we will have to wait until 2024 to fully assess the consequences, in Canada, of the 3.5 percentage point increase in interest rates since March.

This Bank of Canada influence over households and businesses, however, can be exerted more rapidly today, now that central bankers have learned to be clearer and more transparent in their decisions and communications, notes Jimmy Jean. .

One thing is certain, we hope the Bank of Canada soon considers that it has done enough to bring inflation back to its 2% medium-term target, confided Matthieu Arseneau. At the National Bank, it is estimated that this moment will not come before another 0.5 percentage point increase in its key rate, which would take it to 4.25%. But since the situation has already started to change, interest rate cuts can be expected as early as the end of next year.

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