Just one month ago, a lot of smart people were worried that the global economy was about to follow a trajectory similar to that of Thursday’s launch of the SpaceX Super Heavy rocket.
The comparison is only slightly far-fetched.
Following a soaring post-pandemic recovery fuelled by low interest rates and generous government spending, as banks in the United States failed and contagion spread, many feared the recovery would end in tears.
But according to testimony before two parliamentary committees this week, the Bank of Canada’s leading pilots say that unlike the world’s most powerful rocket that exploded into bits after its launch, the Canadian economy appears to be coming to a much softer landing.
Not crashing to Earth
But a grilling by parliamentarians from the upper and lower houses revealed that although there’s confidence the economy will continue to grow in spite of eight consecutive interest rate hikes starting in March 2022, there are many uncertainties for the Canadian, U.S. and world economies.
Shortly after Elon Musk’s rocket came crashing to Earth on Thursday, Sen. Pamela Wallin, chair of the Senate’s standing committee on banking, commerce and the economy, warned of what she called mixed signals for the current economy.
“There’s lots of good news stories, which in the end might not be good news,” she told Bank of Canada governor Tiff Macklem and his senior deputy, Carolyn Rogers. A surging job market, Wallin said, could lead to higher wages and prices, and the hot U.S. economy could add to imported inflation. Overspending by the Canadian government could boost inflation and interest rates.
“We have some economists saying these things … could lead to a recession in the fourth quarter,” she said. “Do you have any such fears?”
Wallin’s question did not represent some strange minority view. A survey of top U.S. economists last week by the Wall Street Journal showed most expected a too-hot economy would lead to inflation — forcing the U.S. central bank to further raise interest rates, ultimately leading to an economic decline.
“With both inflation and interest rates persisting at higher levels than previously expected, economists put the … probability of a recession at some point in the next 12 months at 61%,” the Journal wrote. And unlike various market signals, most of the economists surveyed saw no interest rate cuts until 2024.
‘It’s our job to worry’
As Macklem has said before, Canada’s central bank does not expect rate cuts this year either. And while he forecasts a slowdown, not a recession, he makes it very clear that such predictions are inexact and that slightly positive growth could easily slip into a slight decline. We get a fresh reading of Canada’s GDP on April 28.
So is Macklem worried?’
“It’s our job to worry,” he replied to the Senate committee chair. “We’re always worried.”
Despite his confidence in a soft landing, there is plenty to worry about. Inflation, he said, is still too strong.
While Rogers said stronger and different regulation made Canadian banks quite safe, Macklem said a global and U.S. credit crunch could spread, perhaps to non-bank lenders. As an open trading economy, they said, Canada would feel the effects of a severe global slowdown.
Macklem said it is something he discussed at last week’s International Monetary Fund meeting. Another issue they discussed was what he called “global fragmentation” — the collapse of a mutually beneficial trade regime as the world pulls apart into increasingly hostile trade blocs.
It wasn’t just Wallin who asked about the effect of government spending. At Tuesday’s House of Commons finance committee meeting, several Conservative MPs pressed Macklem to admit that federal budget spending was contributing to higher inflation, but he wasn’t playing ball — insisting that increases in the budget were roughly in line with growth in the economy.
“The way I would put it is that government’s not contributing to the slowing of the economy,” he said. “But at the same time … government spending is not growing considerably above the supply growth of the economy.”
Concerned if spending rises
As for the cost of current civil service wage demands, an outside expert who studies the federal budget told me this week that whether public or private, employers always anticipate and prepare for how they will deal with expected wage increases — even if they don’t talk about it in advance of negotiations.
As both bank governors have repeated in the past, the central bank’s goal is to use higher interest rates to slow growth in demand so that supply can catch up. But in a concession to critics of government profligacy, Macklem made it clear he would be concerned if fiscal spending began to rise further.
Quizzed on grocery prices that continued to rise at near 10 per cent while other prices and wages were rising in the five per cent range, Rogers said food price inflation remained frustrating for everyone.
But like the proverbial man with the hammer, Macklem said the solution to rising grocery prices was two per cent inflation. When inflation is high, he said, companies pass on price rises more quickly.
“When inflation is low, though, when something is more expensive, it stands out and businesses become more concerned they could lose customers if they raise their prices,” he said.
While Rogers and Macklem said there were already signs that food prices were going to come down, a more intractable problem is the impact of high interest rates on housing, which remains expensive and in short supply, as many senators and MPs noted.
Despite a recent resurgence in prices, homeowners remain burdened by interest costs that rose by a stunning 26.4 per cent in this week’s latest data from Statistics Canada. The effect is an example of what Macklem describes as the lag between rate increases and their impact on the economy.
Different this time
While some borrowers must pay more as soon as rates rise, those with five-year fixed rate mortgages will only feel the effects as each individual’s five-year term ends — delaying the impact and extending it into the future. A similar deferred effect happens when banks extend existing mortgage durations to keep payments affordable.
As Wallin said, the strong jobs market may be a good news story that turns bad. Some analysts worry that jobs are traditionally a trailing indicator of an economy that may already be in decline.
In a conversation on Thursday, Trevin Stratton, a top economist and partner in Ottawa with the global financial firm Deloitte, said things might be different this time.
“A number of businesses are expecting a recession to be somewhat short, and they know how challenging it can be to find talent in such a tight labour market,” Stratton said.
It’s one more worry for Macklem and Rogers, who have been hoping current interest rates would slow the job market, weakening an economy that they say is still reaching skyward.