Canadian real gross domestic product (GDP) shrank at a 0.1 per cent annual rate in the first quarter, following a one per cent pullback in the fourth quarter, putting the classic 'two negative quarters' rule for recessions into play. While this is only a rough rule of thumb, the data raises serious concerns about the state of the economy.
Formal Recession Criteria
In Canada, recessions are formally dated by the C.D. Howe Institute's Business Cycle Council, which examines depth, duration, and breadth across employment, income, and output. Although no official declaration has been made, the current trends make it a very close call.
Broader Economic Weakness
This is not just a case of back-to-back contractions. Three of the past four quarters have seen negative GDP growth, pushing the year-over-year trend slightly into negative territory. Historically, such a scenario has often preceded a recession, except during the energy sector meltdowns in 1986 and 2015. The labour market is also flagging, with net job losses and a rising unemployment rate.
The negative headline was particularly disappointing given that the consensus forecast had anticipated 1.5 per cent annualized growth. Even a 4.3-percentage-point contribution from inventory accumulation could not offset the decline. As a result, the Bank of Canada would be ill-advised to consider rate hikes, which have been priced into the Canadian money market over the past two months.
Labour Market Deterioration
The labour market further supports the recession narrative. April saw a loss of 17,700 jobs, contrary to expectations of a 10,000 increase. So far this year, Canada's economy has shed more than 112,000 jobs, a 1.6 per cent annual decline. Despite this, the money market has been pricing in roughly two rate hikes over the coming year.
Credit-sensitive sectors are particularly hard hit. Construction lost 15,700 jobs, while retail and wholesale trade shed 8,300 positions. Manufacturing has also declined in three of the past four months, losing 1,500 jobs in April. These sectors are urging the central bank to begin cutting rates as soon as possible.
Inflation and Policy Implications
With inflation data comfortably within the Bank of Canada's target range, the only factor preventing a resumption of rate cuts is the oil price shock related to the US-Iran conflict. Governor Tiff Macklem would otherwise be discussing further easing. The soft GDP report has already begun to weaken the Canadian dollar, which may provide some relief to the struggling economy.
In summary, the combination of contracting GDP, a weakening labour market, and subdued inflation suggests that the Bank of Canada should avoid any hint of rate increases. Instead, a focus on supporting economic growth through monetary policy is warranted.
