Recession risk low in Canada barring inflation surprise: report

A recession in Canada is unlikely in the coming year, a report from Scotiabank Global Economics says, but an inflation surprise in the second half could force the Bank of Canada to induce one.

With strong economic fundamentals such as low unemployment and pent-up demand, Scotiabank’s model points to a “very low” risk of recession over the next four quarters.

However, the outlook changes quickly if inflation surprises by about 1% throughout the second half of this year.

The Bank of Canada’s monetary policy report released earlier this month said the central bank expects the annual inflation rate to average almost 6% in the first half of this year and remain well above its control range of 1% to 3% throughout 2022 before easing to about 2.5% in the second half of 2023.

Scotiabank’s economists forecast inflation to average around 6% this year and 3% in 2023.

“[I]nflation of just over 7% in the second half of this year would lead to a monetary policy–induced recession in the second half of 2023 as the Bank of Canada would need to increase their policy rate to 4.25% to return inflation to its 2% target,” the report said.

The nominal policy rate in the bank’s baseline forecast is 3%.

The authors also raised the possibility of the war in Ukraine triggering a “mild” recession this year. This stagflation scenario would see commodity prices rise and supply chains further constrained. The recession would be mild due to Canada’s distance from the conflict and commodity exports, the Scotia report said.

Such a recession would allow the Bank of Canada to raise rates more slowly: to 1.5% at the end of this year and 2% by the end of 2023, Scotiabank said.

A report from TD Bank said the BoC can be counted on to hike rates enough to calm demand and slow inflation, while noting that doing so without tipping the economy over into recession will be tricky.

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