RBC expects a short-term recession in Canada. Does it mean we can see lower interest rates?

According to the latest forecast by Royal Bank of Canada, the country will probably face a moderate and short-term recession in 2023, as the economy is suffering from growing inflation, higher interest rates, and issues in the labour market.

“This recession will be moderate and short-lived from historical perspective, and it can be fixed as soon as inflation goes down enough for central banks to cut rates,” – economists Nathan Janzen and Claire Fan wrote in their new report.

RBC’s forecast includes consecutive annual declines by 0.50% in the middle quarters of 2023, followed by growth of 0.2% in the fourth quarter of the next year.

However, Janzen and Fan say the Bank of Canada can’t afford to stop raising rates while it’s dealing with the inflation issue.

“Although higher rates will lead Canada toward a contraction, the BoC doesn’t have a choice. If the inflation keeps exceeding the Bank’s target range of 1-3%, it could destroy almost 30 years of exceptionally successful inflation targeting policy. It may also cause much larger and tougher interest rate increases to settle prices,” – they noted.

Most economists expect the central bank to raise its key lending rate from 1.5% to 2.25% next week, marking the fourth hike in 2022, as the Bank is trying to restrain almost a 40-year record high inflation of 7.7%. In RBC’s opinion, the consumer price index will go up by at least 5.0% in the first quarter of 2023, and then will slowly get back to the Bank’s target range of 1-3%. Nevertheless, a 2% index isn’t expected so far.

Although the recession is coming, RBC’s economists still expect the unemployment rate to go up only modestly compared to the previous downturns as businesses are already facing a “historic labour squeeze.”

As the unemployment rate reached a record low of 5.1% in May, RBC believes the rate will grow to 6.6% in 2023 amid the economic downturn. From a historical point of view, a 1.5% increase is quite modest: RBC says past recessions caused unemployment rate hikes from 0.6% in 1951-53 to even 7% in 2019-20.