Recession imminent.....or is it?

The Canadian media have been trying to talk the economy into recession since at least the second quarter of last year, pouncing on the least sign of weakness while ignoring evidence of continuing strength, particularly in the jobs market. At first blush, real GDP data for Q4/2022, released today by Statistics Canada,  seem to hint that a recession might indeed set in early in 2023, but the details of the reports suggest that the economy has some life in it yet. 

Real GDP was essentially flat in Q4, ending a run of five quarters of positive growth. The key areas of weakness were business investment (for a second straight quarter), housing investment (for a third straight quarter) and business inventory accumulation. The weakness in the first two items in that list is at least prima facie evidence that the interest rate hikes implemented by the Bank of Canada since early in 2022 are having an impact on the real economy. 

That being said, however, some other important components of GDP appear to have remained robust through the end of the calendar year. Most notably household spending, which had edged lower in the prior quarter, jumped 0.5 percent in real terms in Q4. StatsCan identifies particular strength in purchases of durable goods including motor vehicles, a category that might be expected to soften if higher interest rates were really starting to bite.

Alongside the quarterly data, StatsCan also released monthly GDP data for December, which are calculated on a somewhat different basis from the quarterly figures. The data show that real GDP edged down 0.1 percent in the month, but the details show that the weakness was not widespread. Twelve of the twenty industrial sectors tabulated by StatsCan posted positive growth in the month, with the only significant weakness showing up in mining, quarrying and oil and gas extraction. This weakness was at least partly seasonal in nature.  

The fall in GDP in December creates a weak "handoff" into the current quarter, which might be seen as increasing the odds of a recession starting right about now. However, StatsCan's preliminary estimate shows a robust 0.3 percent rebound in real GDP in January, largely as a result of a reversal of the seasonal weaknesses that depressed GDP in December. This means that even if monthly GDP is flat in February and March, Q1 as a whole should still be in marginally positive territory.

Those in the media and elsewhere expressing confidence that the Canadian economy will be in recession through the first half of 2023 need to pause for a rethink. The very strong employment data seen in recent reports do not support the idea that the economy is about to fall off a cliff. Although employment is usually characterized as a lagging indicator, it is hard to believe that private sector employers have been adding jobs even as the real economy weakens all around them.  It might also be noted that, at least in the Toronto region, there are signs of an uptick in the housing market as fears over further Bank of Canada rate hikes start to wane. 

The perception that today's data are "weak" will make it easy for the Bank of Canada to justify keeping rates on hold in the near term. There is certainly some evidence in the data that higher rates are having an impact on the real economy. But are those same higher rates also responsible for the decline in inflation that is now well under way? That's a much harder argument to make.