2024 Canada Economic Outlook: Yielding to Reality

The past year has been complicated for the U.S. and Canadian economies. This time last year many were calling for at least a mild recession in North America in 2023. The good news is we’ve so far managed to avoid that scenario.

But while the U.S. and global economies have beaten expectations, Canada’s economy has struggled to grow, and it appears that it will continue to do so through much of 2024. There are several reasons why. Let’s examine how we got here and the factors that will continue to drive the Canadian economy for the next 12 months.

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BMO forecasts the global economy to grow by just under 3% this year, which is a little below average. The important factor here is that every major economy has seen at least some growth this year, which is an outcome that wasn't obvious at the start of 2023. We previously expected Great Britain, Europe and Russia to experience a mild downturn this year. Instead, they've all managed to grind out some growth. While we do anticipate a slowdown for the global economy in 2024, it’s well short of what we would consider a full-blown recession.

It's also been a surprisingly good year for the U.S. economy, with growth of a bit more than 2% for the full year,¹ which is better than 2022. I dare say that not a single economic forecaster was expecting the U.S. economy to see better growth this year than last. However, we do expect a cooldown, beginning with the current quarter, and we're looking at fairly modest growth of about 1% over the next year.

A lot of the tailwinds that were blowing behind the U.S. economy have now started to ease. Along with the big run-up in long-term interest rates, the conflict in the Middle East and the United Auto Workers strike will likely weigh on U.S. growth over the next year. Nonetheless, we don't foresee any single quarter of negative GDP in the U.S. over the next year.

For Canada, however, it’s been a tougher go. Although the economy has managed to avoid a recession, it's seeing only very modest growth, which we believe will likely continue before we see some improvement by late 2024. Bottom line, BMO expects the Canadian economy to trail behind the U.S. over the next 18 months.

The main reason mostly comes down to the consumer. Overall, consumer spending this year has held up remarkably well in both Canada and the U.S. in the face of inflation and higher interest rates. In part, that relates to the fact that consumers were sitting on a lot of so-called pandemic savings. During the early stages of the pandemic, the savings rate in both countries reached extraordinary levels.

Another positive factor for the consumer on both sides of the border is the underlying strength in the job market. In the summer of 2022, we had the healthiest, tightest job market in North America that we've ever had during peacetime. Canada's unemployment rate fell below 5%,² while the U.S. unemployment rate fell into the low-3% range.³ Since then, we’ve seen a bit of fraying around the edges, and unemployment rates have begun to creep up a bit. Historically speaking, however, jobless rates are still quite low.

With both employment and savings rates high, consumers were able to spend on pent-up demand for travel, entertainment and motor vehicles. But the two countries didn’t spend equally. Even now, Canada’s household savings rate is still over 5%.⁴ While that’s an average rate historically speaking, it’s higher than it was before the pandemic, and higher than the current U.S. savings rate.⁵ Canada’s record level of household debt diverges from the U.S. Moreover, much of the household debt in the U.S. is locked into 30-year mortgages, so it doesn’t turn over nearly as quickly as it does in Canada.

BMO’s view is that over the next year, some of the support factors for the Canadian consumer (pent-up demand and excess savings) will start to ebb. Meanwhile, the high level of household debt and the run-up in interest rates remain in place. Over the next year, Canadian consumers will likely be squeezed even more, which is why we anticipate the economy will struggle to grow over the next 12 months or so.

Inflation has come down from its worst levels in the summer of 2022—a rate we hadn’t seen since the early 1980s—and without a meaningful downturn in the economy. On the flip side, it’s going to be tougher to cut inflation from its current rate of just under 4%⁶ down to where the Canadian and U.S. central banks would prefer, which is closer to 2%. BMO’s view is that we won’t see inflation fall to a comfortable level until late 2024.

An even bigger issue is the relentless rise we’ve seen in long-term interest rates globally. Yields for both the U.S. 10-year Treasury⁷ and the Canada 10-year government bond⁸ have reached levels that we haven’t seen since 2007, which threatens both government finances and the near-term outlook. Simply put, when it comes to interest rates, we’re looking at “higher for longer.”

Our view is that both central banks have done enough in terms of interest rate hikes. They might raise rates one more time, but we’re almost at the top of the mountain. The other side of the coin is that we’re going to be in a higher rate environment for a while until the central banks feel comfortable enough with inflation. We expect the Bank of Canada and the U.S. Federal Reserve to keep interest rates near current levels until the second half of 2024. Even then, we expect interest rates to come down the staircase very slowly rather than an elevator ride down.

The more interesting question is where are interest rates going to settle on the other side? Will we come all the way back down to the extremely low rates we saw in the decade before the pandemic? Or will we settle close to current levels? Probably somewhere in between.

The Bank of Canada’s overnight interest rate currently stands at 5%.⁹ BMO expects those rates to eventually settle into a range of about 2.5% to 3%. That’s higher than anything we saw in the decade before the pandemic, but it’s considerably lower than where we are today. Nonetheless, inflation will have to fall closer to the Bank of Canada’s target before we can realistically talk about interest rate cuts.

BMO has slightly adjusted our odds on the three broad scenarios for the Canadian economy: a so-called soft landing where we avoid any kind of a downturn; a middle ground where we see a mild pullback in the economy; and a hard landing where we go into a full recession. It’s the middle ground that’s become a bit less likely. Long-term interest rates have spiked higher and there’s been an increase in geopolitical risks. Those factors, unfortunately, increase the risk of a hard landing. The good news is that as inflation has come down considerably, so the odds of a soft landing increases, too.

^{1 Gross Domestic Product, bea.gov}

^{2 Canada Unemployment Rate, YCHARTS}

^{3 US Unemployment Rate, YCHARTS}

^{4 Canada Household Saving Rate, Trading Economics}

^{5 Personal Saving Rate, bea.gov}

^{6 Canada’s inflation rate slows to 3.8%, cbc.ca}

^{7 10-year Treasury yield breaks above 4.9% for the first time since 2007, cnbc}

^{8 Selected bond yields, Bank of Canada}

^{9 Daily Digest, Bank of Canada}