With the Bank of Canada’s recent rate hike and the expectation
that there may be another
hike in July, the talk of an economic slowdown and a recession has ramped
up. There is talk and rumor of looming
recession
and that has been underway for some time.
At the same time, another view is that we risk moving into a
1970s style economic environment if inflation is not soon brought to heel. Given
the lag between tighter monetary policy and the economic slowdown that would
bring inflation down, it is possible that any downturn is still up ahead. At the same time, the evidence to date
suggests the economy is not yet slowing down.
Despite higher interest rates, demand is still being fueled by pent up consumer
revenge spending, robust population growth – more people means more consumption
spending - and residual post-pandemic savings.
Figures 1 to 3 show that key economic indicators after post-pandemic re-bound
and adjustment remain robust. Figure 1
presents the Canadian City CPI total inflation rate (from FRED) and while it has been coming down
it is still over five percent and high by the standards of recent history. Figure 2 shows quarterly real GDP growth and while
recent growth at about 2 percent is down substantially from the pandemic
rebound, it is akin to pre-pandemic growth.
There have been no two consecutive quarters of negative real GDP growth –
a traditional hallmark of a recession.
And while 2 percent growth is not great, that is more a long-term productivity
growth problem than anything to do with rising interest rates and recessions. And then there is Figure 3 which shows we are
currently at the lowest unemployment rate in over a decade – again more a sign
of an overheating economy rather than a harbinger of recession.
So, it would appear that until there is evidence to the
contrary, at least another interest rate increase by the Bank of Canada is in
the offing. The economy is still
growing, labor markets are tight, and inflation remains high by historical
standards. The current level of interest
rates seems to be compatible with ongoing inflation in the 4 to 5 percent range
and is unlikely to bring us to the target 1 to 3 percent range of days of
yore. Keeping inflation at the 4 to 5
percent range is dangerous given that any demand or supply side shock when
inflation is already in the 4 to 5 percent range could bring us to double digit
inflation – a 1970s style scenario.
