How the USA and Canada Are Shaping Business Recovery

The Canadian economy will turn a corner towards recovery in the second half of the year, paving the way for a full comeback next year. Although Canada has avoided a recession, the lack of growth is disheartening, as high interest rates have taken their toll. The good news is that interest rate decreases will shortly spark a recovery. Lower interest rates reduce the cost of loan payments, increasing consumer spending and company investment.

Inflation is expected to fall to 2.5 percent this year before returning to the Bank of Canada's target of 2 percent next year.

Immigration remains Canada's not-so-secret weapon, since population increase drives consumer demand and expands the labor supply. At the same time, temporary resident caps, which include international students and temporary workers, will limit population expansion while keeping unemployment and rent rises under control. The public sector will continue to drive job growth, particularly in health care. Consumers continue to be concerned about housing expenses. Despite rising interest rates, households and companies remain resilient and continue to pay their debts. However, increasing debt-service costs require consumers to limit discretionary spending and corporations to hold back investments, which stifles growth. The primary threats to the outlook are the resurgence of inflation caused by a likely depreciation of the Canadian dollar (CAD) against the US dollar (USD) and geopolitical concerns. Inflation, combined with high wage growth, may hinder further rate decreases and consequently recovery. Interest rate differentials and exchange rate Since the start of the recent epidemic, the Bank of Canada and the Federal Reserve have gone in similar directions. They both reduced policy rates to 0.25 percent in March 2020, began hiking rates two years later in March 2022, and have maintained peak rates since July of last year. However, the economies of Canada and the United States are diverging. While the Canadian economy has scarcely risen, the United States' economy continues to develop despite rising inflation and interest rates. Because of the expanding growth difference, the Bank of Canada has already begun to lower its policy rate and will be more active than the Federal Reserve.

The Bank of Canada began the rate-cut cycle in June with a quarter-point drop; we expect four cuts to reduce the overnight rate to 4% by the end of the year.

Meanwhile, the Fed will not begin decreasing interest rates until September, and it may only cut them twice this year. The Bank of Canada will most likely reach a terminal rate of 3% by the end of next year, whereas the Fed may take until early 2026. This disparity in central bank policies may cause the CAD to lose value against the USD. The USD/CAD exchange rate, which is now at 1.36, could move closer to 1.4. Interest rate differentials may lead investments to flow to the United States rather than Canada as investors seek higher returns. Imports could become more expensive for Canadian households and businesses, thereby increasing inflation and posing a danger to the Bank of Canada. The central bank may be forced to keep interest rates higher for longer. However, while we anticipate a visible impact, it will be insufficient to counteract disinflationary forces in the global and Canadian economy. Inflation Disinflationary forces will continue to reduce inflation gradually. The fundamental disinflationary driver is low consumer demand, which occurs as households reduce discretionary spending in response to high interest rates. While half of mortgage holders have renewed their mortgages, the remaining half will face higher interest rates. This suggests that the impact of tight monetary policy on consumer expenditure will persist in the next months and years. If shelter or mortgage interest expenses are eliminated, inflation returns to normal. The consumer price index (CPI) excluding shelter has gone below 2% for three months, while the CPI excluding mortgage interest payments has remained at 2% for three months. Housing is a contentious issue, as housing inflation will continue to surpass the headline figure. However, housing costs are beginning to come down. The condo market is cooling after receiving much-needed supply as building that began during the negative real rate timeframe of 2021-22 is completed. Limits on temporary workers and overseas students will also help to reduce housing demand and rent increases this fall. These are not long-term fixes, but rather temporary reliefs that will keep rent rises under control later this year.

Cooling labour demand means pay growth will likely slow in the summer and fall, contributing to the trend of lower inflation.

Labor market Hiring could increase modestly later this year as rate cuts make investments more appealing to corporations. The unemployment rate will peak at 6.4 percent and continue over 6 percent for the rest of the year and into the following year. The April job data, which indicates that the economy added four times as many jobs as predicted, demonstrates Canada's resiliency. Nonetheless, the undeniable trend over the past year has been a slowing in hiring, notwithstanding the addition of numerous part-time or public-sector employment in recent months. The public sector, which includes health care, education, and public administration, has been an exception because public investments lead to job creation. Over the past year, public sector employment increased by 208,000, while private sector employment increased by only 190,000. The public sector will continue to drive employment until the end of the year, though the trend may moderate as governments deal with increasing debt payments. Population growth will continue to increase the labour supply. While the objective for new permanent residents this year and in 2025 is 500,000 per year, many are already in the nation. In the last two years, the population growth has been driven primarily by entering temporary residents, such as international students and temporary workers. Recent constraints indicate that the labor supply will not rise as much, keeping the unemployment rate relatively low, even at peak, compared to prior rate hike cycles.

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