Royal Bank of Canada (RBC) is the first of Canada’s major banks to predict that the country will fall into a recession next year amid four-decade high inflation, historic labor shortages, and aggressive interest-rate hikes.
In a new set of projections released on Thursday, Canada’s largest bank said it expects back-to-back quarters of negative growth in 2023, a situation economists refer to as a technical recession.
Canada’s resource-heavy economy has been benefiting from the recent boom in energy prices. However, The recession call illustrates the extent to which it remains vulnerable to global economic headwinds and higher borrowing costs that threaten to stall expansions in most major advanced economies, according to a report.
RBC said Canada’s central bank will need to keep hiking into the slowdown to control inflation expectations threatening to entrench price pressures.
“Though higher rates will technically push Canada toward a contraction, the Bank of Canada now has little choice but to act,” according to the report, which was written by economists Nathan Janzen and Claire Fan. “Inflation has been too strong for too long and is starting to creep into longer-run business and consumer expectations.”
Earlier this week, the central bank’s quarterly surveys of executives and consumers showed inflation expectations over the next couple of years have hit a record in Canada: 78% of businesses expect the consumer price index to exceed 3% over the next two years.
“Still, the recession in Canada will likely be moderate and short-lived by historical standards and will be reversed once inflation settles enough for central banks to lower rates,” RBC said.
The Canadian economy is expected to contract by an annualized 0.5% pace in the second and third quarters of 2023, according to the new forecasts. Growth will average 0.8% next year, down from 3.7% this year.
As the economic contraction plays out in 2023, Canada’s unemployment rate will likely rise about 1.5 percentage points to 6.6%, they said, adding that it wouldn’t take long to unwind that weakness in 2024 and beyond.
Toronto Office Vacancies Rise to a Record on Recession Fears
RBC projects the Bank of Canada will raise its benchmark policy rate to 3.25% by the end of this year, from the current 1.5%. The central bank is also anticipated to raise its overnight rate to three-quarters of a percentage point at its next decision on the 13th of July.
RBC cited several headwinds facing the nation’s economy.
As Canadians continue to help fuel an economic recovery in the travel and hospitality sector and higher commodity prices have helped the energy and mining industries, RBC said soaring prices are affecting the purchasing power of households. Meanwhile, the housing market is slipping in certain areas, with prices in Toronto dropping by 11% in four months.
Canada will also feel the spillover from slowing global growth. The US unemployment rate is expected to climb, and emerging markets will struggle with higher food and energy prices and borrowing costs, which will drag Canadian exports.
Even without rate hikes, labor shortages would hamper Canada’s economy as businesses struggle to find workers to grow, Fan and Janzen said.
This article originally appeared on Bloomberg.