The Bank of Canada Is Still Concerned About the Health of the Canadian Economy

After a year in which the Canadian economy experienced virtually no growth, the economy performed better than expected in the first quarter of 2024, with real gross domestic product (GDP) advancing 1.7% on an annual basis.

That’s slower than the median forecast of 2.2% and below the Bank of Canada’s forecast of 2.8%, but it’s still an encouraging sign that the central bank’s monetary policy is beginning to work. Interest rate hikes have helped lower inflation without tipping the economy into a much-hyped recession.

But even the Bank of Canada concedes that the Canadian economy is not out of the woods just yet. There are a number of factors that could derail the Canadian economy.

What Could Derail the Economy?

In early June, Canada’s central bank lowered its interest rates by 0.25 basis points to 4.75%, the first rate cut since March 2020. Even though the Bank of Canada has begun to lower interest rates, borrowing costs are still going to remain above where they were before the 2020 health crisis.

A large number of homeowners will be renewing their mortgages at higher rates in 2025 than in 2020 and 2021. Increased mortgage payments could cut into already tight household budgets, curb non-discretionary spending, reduce economic activity, and lower inflation more than expected. At the same time, additional interest rate cuts could reignite the housing market.

Another key concern for the Bank of Canada is how the country’s economy adjusts to population growth. Last summer, Canada’s population hit 40 million; in the first quarter of 2024, it topped 41 million. Most of that growth was through immigration.

While the larger economy adds to economic growth the surge in population growth comes at a time when the Canadian economy is struggling. In fact, economic momentum is worse than it was before the pandemic. According to Statistics Canada, Canadian productivity is 2% lower than it was in early 2023 and is back to 2017 productivity levels.

In practical terms, Canada is 30% less productive than the U.S., closer to that of Alabama, Mississippi, and West Virginia. More broadly, our productivity gap with the U.S. is approximately $20,000 per person, putting wages 8% below U.S. counterparts. This discrepancy impacts everything from consumer spending to corporate profits and business investment.

Then there are issues outside of our control. Geopolitical tensions in the Middle East, labour disruptions, and even wildfires in Canada could impact oil prices, the supply chain, and inflation.

How could the Bank of Canada combat these concerns? It takes about 18 months for interest rate hikes and cuts to work their way into the Canadian economy. It has announced one interest rate cut this year and is expected to announce three more. That would take interest rates down to 4.0%. Others believe the Bank of Canada will need to be more aggressive.

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