Canada faces growing economic headwinds as key trading partners teeter on the brink of recessionpiling concerns about trade and commodity prices on top of concerns about the domestic economy.
Global growth is being hit on multiple fronts. Central banks around the world, led by the US Federal Reserve, are raising interest rates at the fastest pace in decades, intentionally slowing down their economies to fight inflation.
The European energy crisis escalated this week, with the apparent sabotage of the Nord Stream pipelines that send gas from Russia to Europe. Meanwhile, Britain is in the midst of a currency and bond market meltdown, prompting the Bank of England to intervene in markets on Wednesday and warn of a “material risk to UK financial stability”.
The Organization for Economic Cooperation and Development said earlier this week that it expects the global economy to be $2.8 trillion smaller in 2023 than it projected a year ago. And things could get much worse, the The OECD warnedif a cold winter in Europe leads to power rationing and new gas supplies fail to materialize.
None of this bodes well for Canada’s trade-oriented economy. Most of the debate over a potential recession here revolves around domestic issues, including the impact of Bank of Canada rate hikes on the housing market and the amount of savings consumers have accumulated.
But with forecasters projecting a sharp slowdown in economic growth through the rest of 2022 and into 2023, a drop in foreign demand for Canadian exports or further declines in commodity prices could tip the economy into recession.
“The growth that we’re asking for is so thin that, given the risks that are out there, there really isn’t much room for manoeuvre,” said Stuart Bergman, chief economist at Export Development Canada.
The crucial variable for Canada is what happens in the United States. There, the picture has darkened over the past week as the Fed redoubled its efforts to curb demand in the US economy and rein in prices.
The Fed raised its benchmark interest rate by 0.75 percentage point last Wednesday, to a range of 3 percent to 3.25 percent. The rate hike was expected. But updated projections showed policymakers expect to push the fed funds rate up to between 4% and 4.5% at the end of the year – considerably higher than previously anticipated.
“That materially increases the risks of the US economy having a hard landing. And if the US has a hard landing, I think it’s very hard for Canada not to have one as well,” said Craig Alexander, chief economist at Deloitte Canada.
Even Fed Chairman Jerome Powell acknowledged that the central bank was pushing monetary policy into risky territory. “No one knows if this process will lead to a recession or, if so, how significant that recession would be,” he said at a news conference after last week’s rate announcement.
A US recession would hit a range of Canadian exporters, particularly those linked to interest-rate sensitive sectors. Lumber and building supply companies would be affected by a slowdown in US home construction. Automakers and other durable goods makers would be hit by a pullback in US discretionary spending.
This could be somewhat cushioned by a weaker Canadian dollar. The currency has already lost ground against the US dollar as investors have flocked to US assets as a safe haven, and markets have bet that the Fed will raise interest rates more than the Bank of Canada. A weaker Canadian dollar, in turn, makes Canadian exports more attractive to US buyers.
“The dominant effect is likely to continue to be weaker demand. So Canadian exports will continue to weaken,” Alexander said. “But the fact that the exchange rate is lower means Canadian exports won’t fall as much.”
Beyond the US, the growth picture is even more dire. China’s economy is expected to grow at the slowest pace in decades this year (excluding 2020 and the COVID-19 shock), as the country grapples with strict pandemic control measures and a housing crisis.
In Europe, the war in Ukraine and Russian sanctions have pushed up prices for natural gas and electricity. That is squeezing consumers and making energy-intensive businesses unprofitable, pushing many countries in the European Union, as well as Britain, into a period of stagflation: the painful combination of low growth and high inflation.
The OECD now expects the euro zone to grow just 0.3 percent in 2023, down from a 1.6 percent growth projection in June. The German economy is expected to contract 0.7 percent next year, while the British economy is expected to post no growth.
The energy crisis in Europe presents a mixed outlook for Canadian trade. Some companies will suffer a drop in demand. But Canada’s trade, overall, benefits from high energy prices.
“Commodity exporters are generally benefiting right now from tight global supplies and record prices across much of the commodity complex,” said EDC’s Mr. Bergman, noting that Canadian farmers, miners and energy producers They have done well this year.
“And because many countries, especially in Europe, are looking for energy security…exporting these sources is going to offer growth opportunities,” he said.
Enbridge’s recent $1.5 billion investment in the Woodfibre LNG terminal in Squamish, BC, is one such bet on the world’s growing demand for liquefied natural gas. The federal government, for its part, is interested in exporting hydrogen to Germany through ports on the east coast, although the infrastructure for this has not yet been built.
These, however, are long-term bets. In the short term, swings in commodity prices could have a bigger impact on trade, and many commodity prices are pulling back. The price of a barrel of West Texas Intermediate crude oil, the North American benchmark, fell below $80 this week from a high of $122 in June. The price of copper, often considered a gauge of the world economy, has fallen more than 30 percent since April.
Much depends on how the Organization of the Petroleum Exporting Countries responds to the decline in world demand for oil.
If OPEC countries, led by Saudi Arabia, cut output, that could keep oil prices relatively high, to the benefit of Canadian energy producers. But other geopolitical factors, including the fate of talks over Iran’s nuclear control and further limits on Russian oil and gas exports, could also play a role in energy prices.
“We expect oil to find itself in a period of extreme volatility with prices increasingly disconnected from supply and demand fundamentals and more driven by overall risk,” said EDC’s Mr. Bergman.
EDC is not yet calling for a recession in Canada or the US, and Mr. Bergman said he hopes trade will support the Canadian economy through the economic turbulence ahead. But he acknowledged that the chances of a soft landing are getting slimmer.
“It’s like a bicycle going very, very slowly,” Bergman said. “He’s quick enough to stay upright, but he wobbles a bit. If it hits a pebble, it could tip over. … And there are a ton of pebbles around.”