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In this episode, Scotiabank’s Chief Economist Jean-François Perrault breaks down his latest report on the outlook for the global economy.
It’s a good news/bad news story. Economic growth will be strong — particularly in Canada — this year and next, but interest rates will continue to rise and inflation will be with us for a while.
Key moments this episode:
1:10 - Brief summary of global outlook report forecast
2:44 - Projection for Canada’s economic growth
4:00 – Why there are murmurings of a recession despite growth
5:06 – What inflation might look like in Canada for the next few years
6:57 – What should Canadians make of this good news/bad news economy?
8:42 – Forecast for Canadian interest rates for the remainder of 2022
10:21 – What impact have interest rate increases had on the housing market?
12:12 – Summary of the outlook and what Canadians can expect as we head into the summer
Stephen Meurice: So, the economy is growing. But interest rates are on the rise. There’s lots of jobs out there. But The price of everything is going through the roof. So, you wouldn’t blame the average Canadian if they had the perception the economy isn't doing well.
Jean-François Perrault: So there’s a difference between what's happening and what people perceive is happening.
SM: That’s Jean-François Perrault – Scotiabank’s Chief economist and frequent Perspectives guest.
JFP: People are very much influenced by the cost of living, by the cost of getting groceries, by the cost of gasoline. That’s just the reality that we’re experiencing, even though the fundamentals are strong.
SM: So, is the Canadian economy a good news story or a bad news story? Can it be both? And what do the coming months hold for us all?
The Scotiabank Economics team just released its latest global forecast. And Jean-François, or JF as we call him, is our guest again today. He’ll break down what it tells us about where we’re at and where we may be headed.
I’m Stephen Meurice... and this is Perspectives.
Thanks again for being here, JF always great to have you.
JFP: Thank you.
SM: So, tell me a little bit about this report that you just put out, what's the headline?
JFP: I mean headline depends on where you are in the world, headline in Canada is growth still looks pretty strong. Obviously, there are clouds on the horizon just as there are other parts of the world. But you know, the data that's coming in in Canada still suggests that growth is pretty strong, that there isn't really a need to worry about recession at this point in time, that inflation remains a big challenge and that policy rates still have to go up. We're fortunate it's occurring in the context of reasonably strong growth in Canada, which is not the case, for instance, in Europe or other parts of the world, that are having a much harder time dealing with higher commodity prices than we are.
SM: Okay, so what's the headline for outside of Canada? Is there a single headline for the whole rest of the world?
JFP: I think you can classify them into different blocks. So, if you're a commodity producer, which is Canada, which is the United States, some extent which is much of Latin America and other parts of the world, you're experiencing a pretty strongly positive terms of trade shock, right? The developments in Ukraine, the strength that we've seen in the global economy have all led to strong commodity prices and those are fundamentally good for countries that produce those things like us. If you're not, if you're importing those things like Europeans are for instance, then what's happening is fundamentally more challenging, right? There is reason to believe that there could be a recession there. So, there is this talk of global recession in part because of the impact of Ukraine. Russia, Ukraine on commodity prices. In part because China's growth is slowing down quite substantially because they've locked down to try and control Covid. So, it's really a bit of a tale of two cities. You've got the cities that are exporting stuff that's worth a lot more because of the pandemic and the war. And those countries are those cities that are importing that stuff are finding it challenging.
SM: Okay, let's take a step back to the beginning of that answer and talk about basically what your projection is for economic growth. I got the sense that from very large numbers that we were talking about as we were first coming maybe out of the pandemic, those have been somewhat softened a little bit, but the numbers still look pretty good?
JFP: So, they still look pretty good in Canada. Right? We're looking at probably a little bit below 4% growth this year. A little bit below 3% next year, which are both extremely solid numbers. Now, that's not the almost 5% that we saw in 2021. So, there's a slowdown in growth, but that of course is normal because 2021 saw a big rebound coming out of the major pandemic in 2020. So, we are looking at from a historical perspective, really strong growth the next couple of years, of course if we're right and that's fueled by a bunch of things. It's fueled by commodity prices as we've indicated. But it's also fueled by the fact that we in Canada in particular are reopening a little bit later than other countries. So, the boom in services, the boom in travel, the boom in people going back out that is hitting us full force now. That's kind of already happened in the US some extent. I mean it's gathering steam, but we're a little behind the curve. So, it's a little bit more for us to make up on that front. We're seeing that the numbers and we'll continue to see that the numbers for the rest of the year.
SM: So, if we're talking about 4% growth this year, 3% growth next year, that's nowhere close to recessionary and we're not seeing any contraction of the economy. Normally, I think a recession technically requires two consecutive quarters of contraction of the economy. In spite of some of the chatter out there from what you're saying, we're very far from that.
JFP: I mean we are far from that. Now, people don't feel far from that. So, there's a difference between what's happening and what people perceive is happening and of course people are very much influenced by the cost of living, by the doing groceries, by the cost of gasoline, right? And you know like it or not when you go by the gas station, you see gas over $2 a litre makes people feel like we're in a bad state of the world. That's just the reality that we're experiencing. The challenge with that is even though the fundamentals remain strong, there is a possibility recession in that part of this is psychological, right? If people worry about something and they act on that worry, you know, you got a little bit of momentum on that and that can cause a recession when we don't believe there is a rational economic justification for that at this point in time.
SM: Right. So, you talked about prices, that's obviously a huge subject, really high gas prices heading into the summer when people are going to be going on road trips, all of that. And you talked also about expectations of a recession can be sort of self-fulfilling. And we talked about exactly that when it comes to inflation, that it can be sort of self-fulfilling because people start to act on the basis of their expectations. What does inflation look like in your view? In the short to midterm? Are we going to continue to see inflation really like we haven't seen in several decades for the next year or two?
JFP: Hopefully not for next year or two. I mean we are on a path where inflation in the first half of this year is going to be exceptionally strong by historical standards. And that's a function again of some of the pandemic developments, some of the supply chain issues, the strength in global demand, the strength of commodity prices that's been amplified by the war in Ukraine. A lot of that in our mind is likely to start fading in the second part of the year. So, as we progress through the year, we should see a moderation in inflation. Now inflation is still going to remain high. We're expecting six-and-a-half (percent) on average for Canada this year. And Bank of Canada target is two. By no stretch of the imagination are we thinking we're going back to normal the second part of the year. But some of the factors that contributed to inflation on the way up are going to work to start to moderate inflation as we go into the second part of the year or later in the summer. And that should continue into 2023. Now, a big caveat on that, a big rider on that is inflation expectations do have an important impact on inflation. So if people don't believe inflation is going to come down, it actually makes it difficult for inflation to come down. So, we're in a bit of a dicey period now where central banks are telling us we're going to get inflation down, we're gonna get inflation down to try and make us believe inflation is going to go down in the hopes that that helps inflation going down over the next several months or several quarters.
SM: So, help me out here. If you're a regular person, on one hand, unemployment is low projected economic growth, the economy is going to keep growing this year and next. On the other hand, it's costing you a bundle to fill up your gas tank. Likely you're not getting a raise that's commensurate with what inflation is. Is there a simple way of explaining to people how these forces coalesce? What do you say to somebody who looks at these conflicting signals?
JFP: I mean inflation is not good. Right? So, the higher inflation is, the weaker our purchasing power is, the less we can grow, the less things we can buy because they're more expensive. So, there is an element of the higher inflation gets, the weaker growth eventually will be. There's no question about that. In fact, you can argue that at some point if inflation gets sufficiently high that the interest rate response and the loss of purchasing power that occurs from that become so powerful that you in fact do increase the odds of recession quite substantially. And we actually believe that. We actually, you know, if we think about the principal risk our outlook, so what could cause a recession in Canada? In our mind that's inflation staying stubbornly high in the second part of the year. If it doesn't change, if we don't have a bit of a normalization to return to, well, still high levels, but declining levels of inflation, then this is how these kind of factors all come together that, you know, people worry about recession, they worry about their spending power, interest rates are higher. All that really starts to act as a significant drag on economic activity even though for the time being, you know, prospects are good, job growth has been quite strong, healthful balance sheets. Corporate balance sheets are all very positive and of course the external environment, the price of our exports has been rising very significantly.
SM: So, you keep providing these great segues. You talked about the interest rates and continued interest rate increases and that balancing act in trying to fight inflation. You still foresee interest rates increasing a couple more times this year? We just had a half percentage point increase recently. You see more coming?
JFP: We see the Bank of Canada policy rate going to 3% by the end of the year and they're going to have to be pretty aggressive in making that happen. And this is basically the same thing we expect in the US as well.
SM: What's it at now?
JFP: So, the Bank of Canada policy rates at 1.5%, it's going to go to 3% by the end of the year at least. That's our forecast. And to get there. That needs to happen pretty fast. So, we anticipate, you know, a few more, maybe a couple more 50 basis point moves as we've seen in the last couple of times just to bring the interest rate, the Bank of Canada policy rate in what they called a neutral range, which is in their estimate is between two and three as soon as possible. So that means, you know, next meeting, probably another 50 basis points, possibly the meeting after that, maybe a little bit of a cooling off, but at the end of the year around 3%. Which is a lot higher than where we started off, we started off the year at 25 basis points. So that's big change. And of course, that change is done basically to slow economic activity, try to bring inflation down and of course higher rates affect economic activity, which then affects inflation. So that's, I mean that's been incorporating our forecast when we say, you know, slightly below 4% this year, slightly below 3% next year. That embeds this view of what's going to happen to interest rates. So, we don't think it's critical in terms of its economic impact, it's taking a little bit of the edge off, but there's no question rates are going up. I mean, central bankers have never been as clear and saying we are going to raise rates. Literally, you can take that to the bank because it’s going to happen.
SM: Right, plan accordingly. And one of the biggest ways in which people see the impact of those increasing interest rates obviously is in their mortgage, in the housing market. Which has been frothy, I think is the term they used for the last several years. And suddenly seems to be cooling a little bit now, at a time that traditionally this would be the hot sort of selling season. But it seems to be cooling down a little bit, is that these interest rate increases having an immediate impact on the housing market.
JFP: This is certainly a transmission channel for monetary policy, right. Higher interest rates affect the interest-rate sensitive parts of the economy. And obviously housing is a very interest rate sensitive part of the economy. So, it's not a surprise that the housing market is starting to cool, starting to moderate a little bit or a lot, depending on where you're on at. And that is not particularly worrisome. I mean, that is a very welcome development. It doesn't mean that the housing market is about to collapse. It doesn't mean that, you know, a bubble is bursting. You know, you raise interest rates, you make it a little bit more difficult for folks to buy, that takes a little bit to the oomph out of the market. I mean, if you look across the country, a lot of markets are still in sellers territory or, you know, in the high-balanced sellers territories. So we’re not switched to wholesale kind of sale on housing. That's not happening. We don't think it's gonna happen either because, you know, we've talked about this a lot in the past. There still is this kind of fundamental imbalance between supply and demand in Canada right, that there's just not enough homes relative to population. Now, that's kind of an underlying feature of the market which, you know, at the end of the day, probably supports prices and probably means that as we get through this interesting adjustment period, that upward trajectory in prices continues as we continue not to build enough. But in the meantime, you know, things are slowing and we actually think this is a very welcome development. Like this needed to happen. It needs to happen.
SM: Ok, last word, is this an optimistic outlook that you're seeing for the next little while or pessimistic one or a neutral one? How would you characterize it?
JFP: Well, we don't, I mean, we think of it as realistic as opposed to optimistic or pessimistic. The reality is that people are going to feel uncomfortable. Even though we're telling folks that we think growth is going to be strong. You know, when you're paying more for a lot of stuff, you don't feel good about it. When the housing market is cooling down, you know, that creates a bit of uncertainty. When financial markets are, you know, zigzagging up and down and there's no clear direction. That's stuff that people worry about our internalize. When you travel as a lot of folks will over the summer, it won't be a particularly pleasant experience because a ton of people are traveling now we're not used to that. So, airplanes are full, airports are full, difficult to get hotel rooms, you're gonna pay more for a lot of that. So, there are a lot of things are going to kind of frustrate folks. But a lot of these things that are frustrating are happening because fundamentally the economy is strong. In a way, it's a good problem to have. It's better than the opposite problem. Just, you know, it's too easy to get a flight.
SM: Yeah or it's harder to find a job.
SM: Okay. We'll leave it there for now. JF, thanks so much for joining us again. We always appreciate you coming to talk to us.
JFP: Thanks very much, Steve.
SM: I’ve been speaking with Scotiabank’s Chief Economist, Jean-François Perrault. We will put up a link to JF’s latest forecast in the show notes and on the story page at scotiabank.com/perspectives.