Inflation, housing, Russia: Here’s where the IMF says Canada’s economy is most at risk

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Bank of Canada ‘prepared to act forcefully’ if inflation warrants another rate hike
Bank of Canada deputy governor Sharon Kozicki said Thursday that even though the central bank is open to a pause on interest rate increases, it won’t hesitate to deliver further hikes if a 'very large shock' hits the economy – Dec 8, 2022

Canada is relatively well-positioned following years of economic upheaval but is still at risk of tipping into a “mild recession” or even steeper downturn, according to an assessment by the International Monetary Fund (IMF).

The report released Thursday positions the Canadian economy as an outperformer among its G7 counterparts.

The country has come through the COVID-19 pandemic “relatively well,” thanks in no small part to widespread compliance with public health measures and strong vaccine uptake, the report said.

And while most world economies have been affected by Russia’s war in Ukraine and the resultant disruptions to the global supply chain, Canada’s position as a commodity exporter means it has been “hit less hard” than other countries.

With both fiscal and monetary policy tightening in 2022, the IMF expects Canada’s economy will slow in the years ahead compared with the roaring return from the pandemic recession.

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Canadians lacking faith in economy as grocery bills soar

Unemployment is expected to rise to around 6.2 per cent as inflation returns to roughly two per cent by the end of 2024, according to IMF projections, which largely align with forecasts from both the Bank of Canada and the Liberal government.

Finance Minister and Deputy Prime Minister Chrystia Freeland on Thursday pointed to the report as proof-positive that the federal government is ready to navigate stormy economic waters.

“As we contend with the pandemic’s aftershocks, this remarkable economic recovery has allowed us to reinforce Canada’s social safety net without pouring fuel on the fire of inflation. And critically, it means that Canada faces the global economic slowdown from a position of fundamental strength,” she said in a statement.

But the IMF also outlines a series of risks to Canada’s outlook — both external factors and some unique to the Canadian economy — that could push the country into a steeper downturn than forecast.

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Home prices at ‘unsustainable heights’ during pandemic

The IMF said the rise in interest rates through 2022 has “triggered a welcome housing correction” after home prices rose to “unsustainable heights during the pandemic.”

The report said the run-up in home prices through the first half of 2021 was “fully explained” by the “historically low” mortgage rates on offer and the growing incomes of most Canadian households during the economic recovery.

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With higher rates now cooling the housing market, the IMF expects home prices in Canada to drop 20 per cent or more from their peak to trough before settling.

As of October, the average home sale price in Canada has declined 18 per cent on a seasonally adjusted basis from the peak in February, according to figures from the Canadian Real Estate Association (CREA).

The report states that the financial system is “likely to remain resilient” even as costlier mortgages weigh on Canadian households, but the IMF also flags a need to boost the supply of housing to properly address affordability.

Inflation could prove stickier

The annual inflation rate in Canada eased to 6.9 per cent in October, down from the peak of 8.1 per cent in June but still well above the Bank of Canada’s target of 2.0 per cent.

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While the IMF agrees with the central bank’s timeframe for returning inflation levels to target within two years’ time, the job “could prove more challenging than expected,” the report states.

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If inflation stays higher than baseline past 2024, or if expectations de-anchor and the Bank of Canada is forced to push its policy rate even higher to keep consumer and business confidence in its mandate, the economy could slow more than currently anticipated.

“This would result in slower growth as well as a faster housing correction,” the IMF report reads.

Further spillover from Russia’s war and other global risks

While the IMF said Canada’s economy has been more resilient to disruptions from Russia‘s war in Ukraine, a prolonged conflict nonetheless poses a threat to the economic outlook.

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Continued commodity price volatility adds to the uncertainty of the war’s impact, and the possible need for additional sanctions on Russia could hurt Canadian trade prospects, the IMF said.

Broader conflicts like this and a reduction in international co-operation threaten to fracture the existing global financial system, the IMF notes.

Canada should continue to push its co-operative approaches on the world stage, the fund argues, through multilateral trade agreements and joint efforts for climate change mitigation.

Other threats to Canada’s outlook include additional COVID-19 outbreaks in less vaccinated countries and the risk of cyberattacks compromising physical or digital infrastructure.

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