December 2023 Quarterly Economic Commentary with Builder Member: National Bank

With the support of our Builder Member financial institutions, the OG100 Quarterly Economic Commentary takes an in-depth look at recent economic conditions with a lens specific to helping Ontario’s mid-sized companies make better-informed business decisions.

December 2023 with Builder Member:

National Bank of Canada

Author: Matthieu Arseneau, Deputy Chief Economist & Alexandra Ducharme, Economist NBC Economics & Strategy Group

National Bank is one of the six systemically important banks in Canada. National Bank provides integrated financial services to consumers, small and medium-sized enterprises (SMEs) and large corporations in its domestic market while also offering specialized services internationally. It operates in four business segments—Personal and Commercial, Wealth Management, Financial Markets, and U.S. Specialty Finance and International—with total assets of $404 billion as at October 31, 2022. Learn more at NBC.CA

2024: finding out the cost of fighting inflation

In 2023, central banks around the world tightened their monetary policy further to tackle the inflation problem. The US economy continues to show surprising resilience for the time being, but momentum is fading fast in several countries. Global manufacturing activity has slowed markedly, which seems to be particularly affecting European factories. GDP in the Eurozone has contracted slightly in the third quarter, resulting in no growth over the past year. Meanwhile, authorities are trying to prop up China’s economy, with manufacturers reeling from the effects of the slowdown in global factory activity and property developers continuing to struggle. Given the lag in the transmission of monetary policy and the fact that interest rates will remain restrictive for some time, we expect global growth to slow to just 2.2% in 2024 (compared to an expected 3.0% in 2023).

In Canada, monetary policy tightening has successfully calmed inflationary pressures. As of October 2023, headline annual inflation had cooled to 3.1%, a significant progress from the 8.1% peak reached in 2022. The situation would be even more favorable were it not for the increase in the shelter component, which is rising at a pace of 6.0% year-on-year. Excluding this component, inflation is back to the 2% target, indicating that tight monetary policy has already impacted a significant part of the consumer basket.

While the central bank has itself to blame for the increase in household mortgage interest cost, the surge in rental prices is attributable to a surging population. Over the past year, the federal government has admitted an unprecedented number of temporary and permanent immigrants. This led to a surge in demand for housing, which was not met by enough supply. As a result, rents are increasing at their fastest pace since the early 1980’s.

Against this backdrop, home prices were also resilient, despite elevated interest rates. This combination has set the table for the worst levels of housing affordability observed since the 1980s in several of Canada’s urban centers, with the most marked deterioration in Toronto, where demographic growth has been particularly strong. 

In light of this, sales on the resale housing market have been slowing down since the middle of the year and home prices are dropping. With the fragilizing economy and labour market, activity on the real estate market is likely to remain subdued in the months ahead. However, the strong demographic profile should continue to provide structural support to the Canadian real estate market going forward.

Signs of a cooling economy have been multiplying recently which point to more inflation relief and probably rate cuts sooner than later. Indeed, third-quarter GDP data came in below the consensus of economists’ expectations, showing an outright contraction notably due to a drop in private domestic demand. Consumption has stagnated for a second consecutive quarter.

This is especially worrying given the current demographic context, which is increasing potential GDP growth. On a per-capita basis, GDP has contracted 2.4% over the past year. Historically, a contraction of this magnitude has only been seen in economic downturns.

Although the momentum in GDP growth in September and October (preliminary) suggests that Canada could avoid a second consecutive contraction in Q4, what comes after may be less enviable. According to the Conference Board of Canada, consumer confidence in Q4 was even lower than during the pandemic and the 2008-2009 recession. 

This comes at a time when businesses are facing difficult decisions that could translate into a weak appetite for hiring and, in some cases, even job losses. Indeed, the latest SME confidence survey shows sentiment at recession levels in November, with a lack of domestic demand now the main concern for business owners (as opposed to a lack of skilled labour).

This is corroborated by the labour market, where hiring is not keeping pace with population growth. As a result, the unemployment rate jumped to 5.8% in November, a sharp 8 tenths increase in only 7 months. There has only been one rise of this magnitude outside a Canadian recession since the early 1980s, when the tech bubble burst in 2001. The situation is no better in Ontario, where the jobless rate has risen by 1.2 percentage points since April, now standing at 6.1%.

We believe that this trend is unlikely to reverse in the short term. We note that over a one-year period, profits are down 22.4%, while workers’ compensation is up 6.8%. Given these divergent trends, companies are facing difficult decisions that could translate into a weak appetite for hiring and, in some cases, even job losses.

It is important to keep in mind that this slowdown is occurring as the economy has not yet felt the full effects of past rate hikes. As for consumer spending, a 2018 study by the Bank of Canada showed that the full impact was only felt after 8 quarters, its effect being essentially linear over two years. According to our calculations, it means that no less than 42% of the negative impact of the rate rises has yet to be transmitted to consumption.

All told, we expect the economic outlook to remain challenging in 2024. We expect the Canadian economy to post contractions in the first half of the year resulting in a pullback of 0.2% for the year. 

Ontario could also post a slight contraction (-0.4%) as the level of household indebtedness is higher than the national average and the province’s exports are facing headwinds given the slowing global economy. Progress on the inflation front should enable the Bank of Canada to lower rates by 175 bps in 2024 to give the economy some breathing space.