Recession could arrive as early as Q1, economists say

The fallout from higher inflation and rising interest rates portends an imminent recession, with consumers and sectors affected disproportionately, as outlined in a couple of reports on Wednesday.

RBC economists say Canada’s economy could fall into a recession as early as the first quarter of next year, but they expect unemployment to be “less severe” than in previous downturns.

In a report, the economists said the downturn won’t hit households and businesses equally. Lower-income Canadians will likely be hit the hardest, as purchasing power falls and debt-servicing costs rise.

Higher prices and interest rates will shave $3,000 off the average household’s purchasing power, the report said.

The manufacturing sector will likely be among the first sectors to pull back, while service sectors like travel and hospitality could prove more resilient.

“[T]here remains lingering demand for travel and hospitality services after two years of pandemic lockdowns,” the RBC report said.” That will limit a pullback in these sectors in 2023.”

The jobless rate, which currently sits at 5.2%, will near 7%, it said.

A report from rating agency DBRS Morningstar warned about challenging times ahead amid high inflation, specifically for companies that rely on consumer discretionary demand.

The “negative recessionary forces of decreasing consumer real purchasing power and slowing economic activity are mounting,” the Morningstar report said.

It noted, for example, that wages and salaries haven’t kept pace with the increasing costs of consumer staples, leaving consumers with less discretionary purchasing power. Further, Canada’s real GDP growth rate has declined, it noted; at about 0.8%, the rate was below expectations in each of the first two quarters of 2022.

As such, the financial performances and credit risk profiles of consumer discretionary companies could be pressured, the DBRS report said.

Key factors for these companies will be their ability to pass rising input costs on to consumers, and how such price increases affect sales volumes.

Furniture manufacturer Dorel Industries Inc., one of the companies highlighted in the report, has seen declining revenues and shrinking margins since the third quarter of last year, when sales began to decline in step with more cautious consumers, DBRS noted.

The rating agency expects higher inflation and slower economic activity to continue in the near to medium term, continuing to challenge companies within the consumer discretionary sector.

“[A]s consumer spending becomes increasingly conservative … we expect gross margins and sales volumes to see larger negative impacts,” the report said.

The impacts on companies’ credit ratings will vary on a case-by-case basis, related to product offerings and consumer profiles, it said, with the most affected companies being those that have customer bases of lower-income earners and that offer big-ticket purchases that can be deferred.