As inflation rates remain stubbornly high, central banks all around the world are rapidly hiking interest rates in an attempt to combat it. Although it's proven moderately successful, with inflation slipping in recent months, a new report from Desjardins warns that the intensifying battle "could orchestrate a global recession."
And it seems the groundwork has already been laid. This year, the United States saw its GDP decline for two consecutive quarters -- the general rule of thumb for identifying a recession -- and in Europe, the war in Ukraine is having significant economic impacts, with Desjardins projecting several quarters of contractions for the continent. Unfortunately, Canada's economic outlook does not look to be any more promising.
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"The Canadian economic outlook has rapidly deteriorated on the back of aggressive rate hikes by the Bank of Canada to rein in inflation," the report says. "Slowing demand in interest rate-sensitive sectors, most notably housing, has led to downward revisions to our economic outlook. We expect real GDP to contract in the first half of 2023."
Economic activity was already expected to contract in Canada, the United States, and Europe in the coming months, but what Desjardins argues is that it could be even worse than expected, dragging more countries into a recession.
"We’ll also need to continue to closely monitor the situation in China, where zero-COVID and the resulting business closures could again disrupt global supply chains," the report reads. "The challenges faced by China’s real estate market could also cause demand for certain commodities to plummet."
If Desjardins' predictions are true, this would mean more bankruptcies and sharper market corrections at a global level.
Up to this point, Canada has maintained a growing GDP, seeing a 4% annual rate in the first half of 2022. But as the report puts it, if you look under the hood, it's largely running on empty.
"The healthy headline prints can largely be chalked up to the last gasp of pandemic reopening, as evidenced by surging services consumption," the report reads. "Frantic housing market activity before the Bank of Canada began to step on the brake with colossal interest rate hikes also played its part in Q1."
As borrowing costs increased during the second quarter of this year, interest in residential real estate waned. At the same time, job creation weakened despite record-high vacancies. Looking forward to the end of this year and the beginning of next, that's where we will really see the effects take hold, with an outright contraction anticipated in the first half of 2023, Desjardins says.
"The housing market was the first victim and is likely to experience the most significant drag going forward. Goods consumption, particularly for durables, isn’t likely to be far behind," the report says. "Higher debt servicing costs will continue to eat into discretionary spending, whereas the effect of the reopening boost on services spending is likely now behind."
Even with these possibilities looming, the Bank of Canada appears to be marching ahead with further rate hikes. Desjardins is predicting another 50-basis-point jump in October, with the possibility of more hikes in the following months.
Canada's rate hikes have largely followed step with the U.S. Federal Reserve, but it may not stay that way. The US dollar has remained strong throughout the recent economic shifts, but the Canadian dollar, comparatively, is more interest rate sensitive, meaning rates in Canada will likely top out at a lower level than is seen in the US.
"As a result, the loonie is at risk of losing more ground in the months to come," the report says.
The light at the end of the tunnel is that Desjardins is predicting a cut in interest rates by the end of 2023.
