RBC Economics is warning that the prospect of a soft landing for the domestic economy is becoming a “distant prospect.”
In a note to clients Monday, RBC Senior Economist Josh Nye said the so-called “front-loading” of rate increases – where policymakers increase borrowing rates by greater increments in the short-term in order to shock consumer habits – does not guarantee that they will avoid tipping the economy into recession.
“With policymakers pledging to do what it takes to rein in inflation, we think a soft landing is becoming a distant prospect. Central banks are aware of the challenge but only the [Bank of England] has been bold enough to forecast a recession,” he said.
“For our part, we think a European downturn is already underway as a continental energy crisis deepens. Canada, the U.S. and U.K. are likely to see their own economic contractions beginning later this year or in 2023.”
The Bank of Canada has danced around the prospect for a soft landing in recent communications, most recently with Senior Deputy Governor Carolyn Rogers saying in a speech in Calgary that there would be “bumps” in the road as Canadian consumers adjust to the higher cost of borrowing.
Those comments came on the heels of the central bank unleashing its fifth rate increase of the year, another outsized increase of three-quarters of one per cent. That brought the Bank of Canada’s key policy rate to 3.25 per cent, into what’s known as restrictive territory – where interest rates ultimately constrain economic activity – above the bank’s 2-3 per cent neutral range.
And the Bank of Canada isn’t expected to hit pause any time soon. Markets are pricing in at least another half per cent increase in rates before the central bank may take a pause, taking the policy rate to 3.75 per cent. Bank of Canada Governor Tiff Macklem has signalled as much, telling market watchers in the most recent policy decision that “given the outlook for inflation, the Governing Council still judges that the policy interest rate will need to rise further.”
Inflation, while lower than the peak of 8.1 per cent year-over-year, is still running at 7.6 per cent, more than triple the bank’s two per cent target.
The higher rates are already having a chilling effect on consumer spending, particularly in the mortgage market. Sales activity is down across the board, and both Bank of Nova Scotia and Desjardins expect prices to fall 23 per cent from their February peak to the end of next year.
Economic output has also slowed, with Statistics Canada forecasting a 0.1 per cent decline in July after a disappointing print in the second quarter.
For his part, Nye said rate hikes were the price to pay for getting those sky-high inflation numbers back in check.
“These declines, while unpleasant, are arguably needed to return supply and demand to better balance and ease inflationary pressure,” he said.
“While some of the global drivers of inflation—oil and non-energy commodity prices, supply chain pressures and shipping costs—are easing, domestic price pressures and elevated inflation expectations continue to make “restrictive” monetary policy the preferred path for central banks.”