Inflation keeps rising, will recession follow? Experts say ‘batten down the hatches’

The Bank of Canada’s efforts to tamp down on persistent inflation are increasing the odds of pushing the economy into a recession in the next year, according to some economists.

Consumers should start preparing for a contraction now, experts say, as the threat of layoffs and leaner days looms on the horizon.

Armine Yalnizyan, economist and fellow with the Atkinson Institute, tells Global News that the odds of a recession “are nearing more than 50 per cent in the next six to 12 months.”

Canadian economic output has mostly shown signs of growth so far this year. But Yalnizyan points to the United States’ shrinking economy in the first quarter of 2022 and an increase in applications for jobless benefits south of the border as signs the economic cooling could come north sooner than later.

“I think it’s very difficult for Canada to duck a recession when the United States has one quarter of contraction,” she says.

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James Orlando, a senior economist with TD Bank, agrees with Yalnizyan that there’s “an incredible level of synchronization” between the North American neighbours.

He, like many big bank economists, believes the Bank of Canada will follow the U.S. Federal Reserve’s lead in hiking interest rates 75 basis points in its next announcement July 13.

With Statistics Canada reporting that the annual rate of inflation soared to 7.7 per cent in May, the central bank will be pressured to act swiftly and show Canadians that it will take the necessary steps needed to stifle inflation, Orlando says.

TD Bank’s economic forecasts released this past week show a significant slowdown in consumer spending by late 2022 and into early next year.

TD believes the slowdown will narrowly skirt negative growth, but Orlando points out that the Bank of Canada will have a “very thin margin of error” as it drives up interest rates to avoid a recession — the sweet spot economists call a “soft landing.”

“It is effectively reducing demand to such an extreme, such a level that it is hoping inflation will turn around and come back to target. It needs to make sure it doesn’t crush the economy as it goes through that process,” he says.

Orlando notes, however, that recessions do typically follow rate hiking cycles.

“They’re engineered to slow demand,” he says.

The start of a recession is typically marked by two consecutive quarters of negative growth in a country’s gross domestic product.

The housing sector, which has already showed signs of a slowdown and price drop in some markets, is especially vulnerable to rising interest rates used to tamp down on inflation.

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“Overall, this (soaring inflation) puts the chance of a recession higher, when you raise interest rates to the point where housing’s affected, where growth in general is affected,” Allan Small, senior investment adviser at IA Private Wealth, said earlier this week in an interview with The Canadian Press.

Observers say fears of a recession are already having an impact on markets, with energy stocks on the TSX taking a hit this past week.

While Canadian oil and gas stocks have performed exceptionally well for much of 2022 due to Russia’s invasion of Ukraine and the resulting disruption of global energy supply, Small said this week that some investors are beginning to worry that a broad-based recession — if it happens — will take a bite out of surging demand.

“When you have a recession or a fear of recession, that basically slows down everything. So the demand side of the equation starts to wane,” he said. “You don’t have as much of an imbalance, you’re more balanced, if people aren’t going to travel as much and aren’t going to move around as much.”

In addition to hurting consumer demand, the higher interest rates go, the more businesses will be squeezed. That could lead to layoffs, Yalnizyan says.

“The bigger issue about central banks raising rates is if they make it more costly for businesses that are highly leveraged to borrow. That will cool the rate at which they’re hiring, and some firms that were over-leveraged may start laying people off. And that’s the part we are worried about,” she says.

“Whether that happens in sufficient numbers to be problematic is the chapter that is yet unwritten … but it’s not a direction that you want to be moving towards at all because your best hedge against inflation, as a household, is a good job.”

If Canada is indeed heading for a recession, Orlando says the positive news is that the past few years have been good to the average consumer.

Job growth has been plentiful, the average household has been able to save a fair bit during the pandemic and those lucky enough to break into the housing market have seen their equity grow rapidly.

Those factors could help insulate Canadians against rising interest rates and high inflation, Orlando points out.

“There is a buffer, which is the stockpile of Canadian savings that will hopefully be able to withstand some of these headwinds that are facing pretty much everyone,” he says.

But Sprott School of Business professor Ian Lee told Global News recently that recession or no, now is the time to “batten down the hatches” as the Canadian economy enters a period of “great uncertainty.”

Bills like mortgage payments and hydro bills will need to be prioritized in the months ahead, as will groceries. Everything else should be up for discussion for reducing or eliminating entirely, he says.

“That means cutting out unnecessary spending, frivolous spending,” he says.

“Save that money for the rainy day and the thunderstorm that we think is coming.”

— with files from Global News’ Anne Gaviola and The Canadian Press

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