Interestrateincreasesbite,leadingtodeeperrecessionEconomicoutlook|January2023ForewordRecessiontalkhasrampedupoverthepastfewweeksasthereasonstosupportthenegativeturninsentimentstackup.TheBankofCanadahashikedinterestratesbymorethanweanticipatedafewmonthsago,atrendthatischippingawayathouseholdpurchasingpower.Higherborrowingcostshavecreatedaheadwindforbusinessesthatwanttoinvest.Andaggressivemonetarytighteningisn’tlimitedtoCanada:theEuropeanCentralBankandtheUSFederalReservearealsoembarkingonrapidtighteningcampaigns,whichareexpectedtotiptheseeconomiesintorecession.Whilearecessionhasbeenexpectedintheeurozoneformonths,thedowngradedoutlookfortheUnitedStateswillhitCanadahard,givenourtradedependenceonoursouthernneighbours.Householdsarebeingbatteredbythedoublewhammyofhighinflationandrisingborrowingcosts.Higherinterestrateshadanalmostimmediateimpactontheresalehousingmarket,aselevatedmortgageratesshrankthepoolofpotentialbuyerswhoqualifytoborrow.Asaresult,we’veseenhouseholdinvestmentsinrealestatetumblesincethesecondquarterof2022.

Ofcourse,higherinterestratesarealsopinchingcurrentborrowers.Recentdatashowstheimpactondebt-carryingcosts:inthethirdquarteroflastyear,interestpaymentsonhouseholddebtincreasedby16.2%—thelargestjumponrecord.Indollarterms,interestpaymentsincreasedby$16.4billionfromthepreviousquarter.Fromaneconomicspointofview,becauseconsumptionisthelargestcontributortoourgrossdomesticproduct(GDP),that$16.4billionbeingredirectedawayfromspendingandsavingiscreatinganotableheadwindtogrowth.Giventheincreaseininterestpayments,it’snotterriblysurprisingthatrealhouseholdspendingfellinthethirdquarter.Unfortunately,interestpaymentsaresettocontinuetoincreaseoverthecomingyear,squeezinghouseholdbudgetsandleadingtoyetmoredeclinesinconsumerspending.Incontrast,businessescontinuedtogrowtheirinvestmentspendinginthelatterpartof2022.Severalfactorscontributedtothis.Businessinvestmentisstillplayingcatch-upfromthelastrecession,andverystronggrowthincorporateprofitsinthepandemic’saftermathishelpingpadcapitalEconomicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 2Forewordexpenditure(capex)budgets.Further,labourhasbecomeincreasinglyscarceinCanada,creatinganincentivetoinvestinproductivity-enhancingcapitaltohelpoffsetstaffshortages.Despitethis,businesssentimenthasbeentrendingdownwardoverthepastfewmonths.It’sexpectedtoremainsubduedastheUnitedStatesentersamildrecessionanddomesticconsumerspendingcontinuestodecline.Inaddition,businessinventoriesremainatanunsustainablyhighlevel,whichwillcreateadisincentivetoinvestinnewcapacityuntilthecurrentstockpilesdecline.Soeventhoughcompaniesareexpectedtospendmore,thegainwillbemodestbecausethey’realsoexpectedtotakeacautiousapproachtoinvestingoverthenextyear.OurforecastassumestheBankofCanada’srate-hikingcyclehasfinished.Atitscurrentlevelof4.25%,theovernightrateishighenoughtoberapidlycoolinggrowthbuttoohightobesustainableinthelongerterm.Indeed,ourforecastpredictsthesteadydiversionofhouseholdincometowardinterestpaymentsandaUSrecessionwillpushdownCanadianeconomicgrowthfor

threeconsecutivequarters,resultinginanoverallcontractionof0.9%thisyear.Inresponse,inflationshoulddeceleratesharply.ThiswillallowtheBankofCanadatobeginunwindingsomeofitsrestrictivemonetarypolicybeforetheendof2023.Ratecutsthroughout2024willprovidestimulusandallowforamodestrecoveryinactivity,withamorerobustreboundinstorefor2025.Whileallthismaysoundquitedire,westillexpecttherecessionwillberelativelymildandshort-livedbyhistoricalstandards.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 3FiscalandmonetarypolicyThedominanteconomicthemecontinuestobeinflationandthemonetarytighteningrequiredtocoolpricegrowth.Thegoodnewsisthatweareincreasinglyconfidentthatpeakpricegrowthisbehindus,withinflationdeceleratingsteadilysincehitting8.1%inJune2022.Weexpecttoseepricegrowthcontinuetoslow,withmoderationalreadyevidentingasolineandfoodpricesaswellashomeownerreplacementcosts,instepwithslidinghousingprices.Inflationremainsuncomfortablyhigh,however,whichwillkeeptheBankofCanadavigilantinitsfighttoreturnpricegrowthtoitstargetof1%to3%.Topushdowninflation,theBankimplementedasteadystreamofinterestrateincreasesthroughout2022.Itannouncedsevenconsecutivehikesandthelatest,a50-basispointbumpinDecember,broughttheovernightrateto4.25%.Thisyear-endmovewasaccompaniedbyashiftintone,signallingapotentialpauseininterestratehikes.We’llknowmoreaftertheBankofCanada’sJanuarymeeting.

RealGDPgrowth(percentchangeatannualrates)86.921.50.00-2-1.6-2.3-2.2-3.4-42021Q12021Q22021Q32021Q42022Q12022Q22022Q32022Q42023Q12023Q22023Q32023Q42024Q12024Q22024Q32024Q4Sources:StatisticsCanadaandDeloitte.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 4FiscalandmonetarypolicyItusuallytakesbetween12and18monthsformonetarypolicychangestotakefulleffect.Theimpactsofrecenthikeswerejustbeginningtomaterializeinthethirdquarterof2022,leavingsubstantialjustificationtoadoptamoredata-dependentapproachtofuturepolicymoves.Marketsarealsobeginningtopriceinaneasingofmonetarypolicy.Theyieldcurve(asmeasuredbytheyieldon10-yearbondsminustwo-yearbonds)turnednegativeinJuly2022andhasbecomeprogressivelymoreinverted.BytheendofNovember,theyieldon10-yearbondsreached100basispointslowerthantwo-yearbonds1.Wehavenotseensuchinversionsincebeforetherecessionoftheearly1990s;however,wedon'texpectthesteepdeclinesinhouseholdspendingandbusinessinvestmentthatwesawbackthen.Withinflationslowingandtheeconomyenteringarecession,theBankisexpectedtobeginreversingitspolicystancebytheendofthisyear.Monetaryeasingisforecasttocontinuethroughout2024astheBankslowlybringsitspolicyinterestratebackdownuntilitreachestheupperboundsoftheneutralrate,estimatedtobe3%.

Wewilloftenseefiscalpolicyrespondinastimulativewaytoabuddingrecession.Thistime,however,wedon’texpecttoseegovernmentsstepinwithalarge-scalereliefpackagedespitetheirbetter-than-expectedfiscalpositions.That’sbecausethecomingdownturnwasorchestratedbypolicytosubdueinflationbyrealigningdemandandsupply.Therefore,iffiscalpolicyweretobecomeoverlystimulative,itwouldtriggertheBankofCanadaintooffsettingtheimpactbytighteningmonetarypolicy.Sometargetedreliefmeasureshavealreadybeenannounced,buttheprimarytrendonthefiscalfrontremainsanunwindingofpandemic-eraspending.Assuch,governmentspendingandinvestmentisexpectedtodeclinethisyearbeforereturningtogrowthin2024.BankofCanada,SelectedBondYields,accessedDecember2022.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 5HouseholdsandbusinessEconomicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 6HouseholdsThe400-basispointincreaseintheBankofCanada’spolicyratesinceMarch2022iscrushingCanada’shousingmarket.HomesaleslastOctoberfell36%fromtheirFebruarypeaks,wipingoutgainsoverthepasttwoyearswithrealactivity(asmeasuredbyownershiptransfercosts)down17.4%frompre-pandemiclevels.Asdemanddriesup,pricesarealsofalling,withtheaveragehomeresalepriceinOctoberdownmorethan20%fromitsFebruarypeak.Thehousingmarketoutlookisbleakoverthenexttwoyears,asresidentialinvestmentisexpectedtodropanother7.9%thisyearafterfallingby10.6%in2022.Despiteanexpectedpauseininterestrateincreases,mortgagerateswillremainelevateduntiltheendof2023,preventingmanyprospectivehomebuyersfromenteringthemarketandleadingtofurtherdeclinesinhomeownershiptransfercosts.Investmentinhomerenovationisexpectedtodropanother6.5%,followingthe4.1%declinein2022,asresalemarketactivityremainssubduedandfallinghomepricesleadtoacautiousapproachtospendingonhomeupgrades.Thegoodnewsisthatthelowlevelsofactivitythisyearwillnotlastforever—weanticipatethehousingmarketwillslowlystarttorecoverin2024and2025aslowerinterestratesworktorestoremarketdemand.

Ontopoftheplungeinhomesales,theexpectedslowdowninnew-homeconstructionisanotherkeycontributortothepessimisticnear-termoutlookinresidentialinvestment.Housingstartsrampeduprapidlyinthespringandsummerof2022,butsuchafastpaceisnotsustainablewhendemandcoolsandhomebuildersfacehighercosts.Asthecyclicaldownturnhitsthenew-housingmarket,startsareexpectedtodeclineoverthenextthreeyearsbeforereturningtogrowth.Whilespendingonhousingwasthefirstareathathouseholdscutbackon,risingdebt-servicingcostsandhighinflationarecausingthepullbackinspendingtoextendtoconsumerpurchases.Consumerspendingfellby0.3%inthethirdquarterof2022,andweexpecttoseedeclinescontinueoverthefirsthalfofthisyear.Thesedropswillnotbebroad-based:goodssensitivetointerestrates(suchashouseholdfurnishingsandappliances)willgethitthehardest,whilediscretionaryspendingonservicessuchascommunication,recreation,andcultureservices,aswellasaccommodationandfoodservices,willalsodecline.Meanwhile,otherservices—includingtransportation—willcontinuetoenjoysomegrowth,supportedbyadrawdowninsavings.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 7HouseholdsOverallrealspendingonhouseholdgoodsandservicesisexpectedtogainjust0.7%thisyear,beforegrowthacceleratestoa2.9%pacein2024.Oneofthewildcardsinthisforecastiswhatwillhappentolabourmarkets.Traditionally,recessionsareassociatedwithnotablejoblossesascautiousbusinessestrimtheirpayrollstoadjusttodeceleratingdemand.Thistime,however,thesituationissuchthatbusinesseswillneedtobalancetheexpectedsofteningindemandagainstascarcityoflabour.Throughoutthe2010s,themajorityoflabourforcegrowthinCanadawasduetopeoplemovingtothecountry.Withimmigrationlevelsplummetingduringthepandemic,welostakeysourceoflaboursupply.Thelevelsarenowrecovering—butjustasasurgeofbabyboomersretire,resultinginlittlereprievefororganizationsthatarestrugglingtofindworkers.Indeed,jobvacanciesremainelevated,especiallyinlower-payingjobsthathavenohybridworkoptions.

Giventhesetightlabourmarketconditions,wedon’texpectemploymenttodeclineoverall.Employerswilllikelybereluctanttoletgooftheirworkersforfearofnotbeingabletofillthosevacantpositionsoncetheeconomybeginstorecovernextyear.Todate,we’veseenthatreluctanceshowupinstrongjobdatawithsolidemploymentgrowthinOctoberandadeclineinunemploymentinNovember.However,it’snotgoodnewsacrosstheboard.Joblossesareexpectedintheindustriesthataresufferingthemostinthecurrentconditions:construction,wholesaleandretailtrade,transportationandwarehousing,andinformation,culture,andrecreation,amongothers.Despitetheseisolatedlosses,weforecastthecurrentlabourmarketwillprovideimportantsupportfortheeconomythatwillpreventthedownturnfrombecomingdeeperthanitwouldbeifemployersweremoreaggressiveincuttingtheirpayrolls.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 8BusinessPerhapsthemostsignificantchangefromourSeptember2022outlookisthatwenolongerexpecttheUSFederalReserve(Fed)willbeabletoorchestrateasoftlanding,whichmeansourlargesttradingpartnerwillslipintorecession,albeitamildone.AsinCanada,theUSrecessionwillbeapolicy-inducedone.TheFedraiseditstargetforthefederalfundsrateby50basispointsatitsDecembermeetingbutinsteadofsignallingapotentialpause,astheBankofCanadadidonthissideoftheborder,membersoftheFederalOpenMarketCommitteeindicatedinterestrateswouldneedtopushhigher.WhileinflationhaspeakedintheUnitedStatesitremainswellabovetheFed’stargetandabovethelevelCanadaisexperiencing.ThedowngradetotheUSoutlookhasimportantimplicationsforourtradeoutlook.Forstarters,weexpecttoseeCanada’sexportsfallearlythisyear.Afterpostingstronggainsinthesecondhalfof2022,oilexportsareforecasttoretreatmodestlyinthecomingmonthsasenergydemandfallsalongsideadeclineineconomicactivity.Ontheotherhand,exportsofagriculturalandfisheryproductswilllikelyrecover,mainlyduetowheatandcanolaasthesectorrecoversfromdroughtconditionsin2021andtostrongglobaldemandandhighproductpricesbecauseofthewarinUkraine.

Ontheinvestmentfront,businessesareexpectedtocontinuetoexpandthefundingtheydirecttowardnewcapitalandmachinerythankstorecord-breakingcorporateprofitsduringthepandemicrecoverydrivenbystrongdemandandrapidlyrisingcommodityprices.Inthesecondquarterof2022,corporateprofits(measuredonanationalaccountsbasis)weremorethandoubletheirpre-pandemiclevel.Despitetheirdeclinetoamorenormallevelastheeconomycontracts,thataccumulatedsurpluswillallowcompaniestocontinuetoinvest.Whileitmayseemcounterintuitivetodosoduringaperiodofeconomiccontraction,investingwillallowthemtocontinuetogrowdespitethechallenginglabourmarketconditions.Nevertheless,wehavedowngradedouroutlookforinvestmentspendingtoaccountfortheeconomicdownturnandthefactthathighinventorylevelsmayslowbusinessspending.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 9OutlookbyprovinceEconomicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 10OutlookbyprovinceWithadeeperrecessionexpectedacrossthecountry,fewprovinceswillbesparedadeclineinoutputthisyear.OnlyManitobaandSaskatchewanwillenjoypositivegrowth,duetothereboundintheiragriculturalindustriesafterdroughtconditionsdramaticallysuppressedoutputin2021.Theseprovinceswill,nevertheless,besubjecttothesamedownturnindomesticdemandthat’shittingfromcoasttocoasttocoastasCanadiansgrapplewithhigherinterestratepaymentsandtheimpactsofaUSrecession.Provincesontheeastcoast,whichhavemoretradeexposuretotheEuropeanmarketthantherestofCanada,willfeelthepinchoffallingdemandfromEurope,whereadeeperrecessionisexpectedcomparedtootherareas.ForestryplaysalargeroleinNewBrunswick’seconomy,sotheprovincewillkeenlyfeelthedownturnintheNorthAmericanhousingmarket.Withhigherdebtpaymentsandinflationpinchinghouseholdbudgets,therewillbelessmoneyavailablefordiscretionaryspending,whichwillnegativelyaffectthetourism-dependenteconomyofPrinceEdwardIsland.Thankstoasurging

housingmarket,realestateandhousingrentalandleasingwasNovaScotia’slargestindustryin2021;asthehousingmarketcools,we’llseeoutputinthissectordecline,bringingdowneconomicgrowthwithit.OverinNewfoundlandandLabrador,increasedinvestmentintheminingindustrywillnotbeenoughtokeeptheprovinceoutofrecession,althoughthatsupportwillhelpmitigatetheimpactofaslowdownindomesticdemand.TheeffectsofthehousingmarketdownturnwillbemorepronouncedincentralCanadaandBritishColumbia.OntarioandBritishColumbiahavebyfarthemostexpensivehousingmarketsand,therefore,thehighestdebtburdens.Withinterestpaymentsrising,debt-servicingcostswillhavethebiggestimpactintheseprovinces,withmostsectorsoftheeconomybeingaffectedbythereductioninhouseholdpurchasingpower.Rubbingsaltintothewoundisthetwo-yearbanonforeignhomebuyersandvacanttaxincreasesthatwillfurtherweighonthehousingoutlookintheseprovinces.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 11OutlookbyprovinceMeanwhile,QuebecandOntarioareveryexposedtoconditionsintheUnitedStates,sothedownturnsouthoftheborderwillnegativelyaffectexportprospects.Thiswillbringdowngrowthinbothprovinces.TheAlbertaeconomyisnowexpectedtoenterarecessiongivenitshighdebtlevels(trailingonlyBritishColumbiaandOntario)andthereductioninoildemandfromtheUnitedStates.Despitethesefactors,thedownturninitshousingmarketisexpectedtobemildrelativetootherprovinces,andstrongpopulationgrowthwillhelpAlbertaweatherthemodestpullbackexpectedinenergydemand.

RealGDPgrowthbyprovince,percentchange2021202220232024Newfoundlandand0.62-0.31.4LabradorPrinceEdwardIsland7.94-1.51.4NovaScotia6.23.5-1.11.2NewBrunswick5.82.5-1.51.2Quebec63.6-1.31.3Ontario5.12.4-1.31.9Manitoba2.2Saskatchewan-2.1Alberta4.95.1-1.11.8BritishColumbia6.23.8-1.31.8Sources:StatisticsCanadaandDeloitte.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 12FinalthoughtsEconomicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 13FinalthoughtsTheeconomicoutlookremainscloudedbyuncertainty.Thebiggestriskisthatthepastyear’sinterestrateincreaseswillbemoreconsequentialthananticipated,leadingtoadeeperandmoreprotracteddownturn.There’sstillariskthatpolicymakerswillraiserateshigherthanweexpect,whichwouldalsoleadtoadeepereconomicdecline,bothhereandintheUnitedStates.Onepotentialupsideisthatconsumerscouldchoosetonotcutbackontheirspendingandinsteaddrawdowntheirsavingsordefertheirhigherinterestpaymentsbyextendingmortgageamortizations.Inanenvironmentofslowingdemand,elevateduncertainty,andtightlabourmarkets,thereareafewthingsthatbusinessescandotoweatherthestorm:Theycanconductascenarioanalysisthataccountsforupsideanddownsideriskstotheeconomicoutlook,toassesshowrevenuesandprofitscouldchangeunderdifferentcircumstances.Havingthisinformationandknowinghowtoidentifywhentheserisksbegintomaterializeequipsthemtoquicklyshiftgearsandadoptnewplansifnecessary.Theycanbestrategicwiththeirstaffingplans.Despitetheloomingrecession,arecentsurveyreportedonbyBNNBloomberginDecembershowedthathalfofCanadianworkersplantolookforanewjobinthefirsthalfof2023,within-demandprofessionalslookingtoleveragetightlabourmarketstochangejobsandboosttheirearnings.Companiesthatarefacingtalentshortagesshouldbeseekingtoidentifyanddirectanyretentionmeasurestotopperformers.Theycanalsobestrategicwiththeirinvestmentplans.Organizationswillneedtocarefullyconsiderwhatresourcesthey’llneedwhentherecoverytakesholdandensurethey’rereadytorespondwhendemandbeginstoaccelerate.ThisisshapinguptobeanotherrockyyearfortheCanadianeconomy.Butwe’regettingratherusedtocallingonourresilienceandactingnimblytopositionourselvestoweathertheeconomicstorm—theupcomingrecessionissimplythelatestwave.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 14Keyeconomicindicators2022202322F23F24FQ1FQ2FQ3FQ4FQ1FQ2FQ3FQ4FRealeconomicactivityGrossdomesticproduct-2.2-3.4-1.60.01.53.4-0.91.8Householdconsumptionexpenditure2.39.5-1.0-0.1-0.30.00.72.9?Durablegoods8.0-14.4-8.2-1.8-1.8--3.3-2.72.8?Services2.53.3Residentialinvestment8.8-31.5-15.4-9.4-4.1-2.7-1.60.8-10.6-7.91.4Non-residentialfixedinvestment7.717.01.31.01.6?Non-residentialstructures13.313.80.3-0.20.011.84.00.6?Machinery&equipment-1.323.1-Governmentconsumption&investment0.7-2.23.9-3.2-1.4-1.0-0.60.8Exportsofgoods&services-4.0-3.7Importsofgoods&services0.229.5-1.50.0-1.0PricesConsumerpriceindex(y/y)3.72.4ImplicitGDPpriceindex(y/y)4.41.4-LabourmarketEmployment3.23.9-Unemploymentrate(%)6.06.0Note:Unlessotherwisenoted,allfiguresareexpressedasannualized%changes.Sources:StatisticsCanadaandBankofCanada.ForecastbyDeloitteEconomicAdvisory,asofDec.13,2022.Economicoutlook|January2023 ?DeloitteLLPandaffiliatedentities. 15Keyeconomicindicators2022202322F23F24FQ1FQ2FQ3FQ4FQ1FQ2FQ3FQ4FInterestrates(%)Overnightratetarget0.331.172.753.954.082.044.213.113-monthT-bill0.641.684.314.284.082.414.263.091-yearGoCnote1.402.583.654.464.684.624.604.413.024.583.452-yearGoCnote1.712.723.494.134.334.324.334.213.014.303.485-yearGoCnote1.962.803.143.774.022.924.173.7010-yearGoCbond2.082.952.993.553.853.994.013.79Yieldcurvespread(pp)3-monthvs.10-year1.441.30-0.24-0.58-0.53-0.33-0.180.050.48-0.250.692-yearvs.10-year0.370.23-0.50-0.58-0.49-0.34-0.23-0.08-0.12-0.290.30ForeignexchangeUSD/CAD($C)1.271.281.311.361.361.341.331.311.301.341.30CAD/USD(UScents)0.790.780.770.740.740.740.750.760.770.750.77Sources:StatisticsCanadaandBankofCanada.ForecastbyDeloitteEconomicAdvisory,asofDec.13,2022.Economicoutlook|January2023 ?DeloitteLLPandaffil