Assessing a recession

What goes into generating an economic slump?

There’s speculation that the Canadian economy may experience a recession at some point in 2024 – and maybe it will. This speculation first arose and has persisted since 2023, when Canada’s inflation rate surged to levels unseen in decades.[1] Then came a series of interest rate hikes that drove Canadians’ mortgage and loan payments to their highest levels in 20 years.[2] The talk grew louder still when data began showing that economic output was starting to sputter. Despite all these developments, a recession has yet to officially materialize.

So why hasn’t it? While it may be easy to toss the word around to describe any serious economic downturn, the technical definition of recession is a drop in gross domestic product or GDP (the market value of all the final goods and services produced in a specific time period by a country) for at least two consecutive financial quarters (about six months). Even negative GDP in one quarter may not be enough to convince experts to declare a recession, especially if some major sectors of the economy continue to show strength and growth.

Let’s take a closer look at the various elements that contribute to – and often signal – a recession.

Unemployment

Fears of a looming recession can intensify when unemployment figures begin to spike. In a slowing economy, some employers will take action to cut the size of their workforce to reduce expenses. The tactic has a ripple effect: Fewer people working means fewer being paid. And lower spending by people who are out of work puts additional weight on an already struggling economy.

Consumer spending

Regardless of their employment situation, consumers facing a recession will feel pressure to trim their spending knowing that the economic downturn can wreak havoc on their finances. The prospect of sticky inflation, large-scale job losses and higher borrowing costs makes consumers more likely to spend less and tighten their belts in preparation for more challenging times.

Securing credit

Another sign that a recession is pending or underway is difficulty in securing loans and credit as applications face more scrutiny and stricter lending rules. Depending on credit rating, current employment status and ability to meet the payment terms, borrowers may have a harder time landing a big loan for a new car, home renovations or other large purchases. Difficulty accessing credit means people have less money in their pockets to drive the economy, dampening an already woeful financial forecast.

Real estate

Canada’s hot housing market has burned intensely for years, but the usual brisk sales activity slowed amid recent economic uncertainty and the higher cost of borrowing. When interest and mortgage rates rise, people can become more cautious about a substantial investment such as buying a house. At the same time, fewer people will decide to sell their home (unless they’re forced to do so by an inability to pay the bills), which contributes to idling or declining property and home equity values. A flat real estate market sends a strong signal that the economy is transitioning.

Market volatility

Stock market performance can gauge the likelihood of recession. Falling stock prices show waning confidence in market valuations. Market volatility can also worry investors, who might react with unease or panic. Fearing things may get worse before they get better, some might go so far as to sell their holdings at a loss or shift into more conservative investments. This can place more downward pressure on market values and spawn a bear market – a state of low investment and less frequent and profitable market activity.

On the other hand, lower stock values are an opportunity to buy more shares at lower prices. By being patient and staying invested for the long term, shareholders can watch the value of their stocks rebound and grow as a stabilizing economy develops, with the potential to reach new highs.

Small businesses

The small and medium-sized business sectors are regarded as the backbone of the Canadian economy. They’re also highly vulnerable to recessions. Less business activity during tough times can force businesses to cut jobs and curtail investment in their operations to stay afloat. This can reverberate across communities, which may face a challenging road to recovery if their small businesses have suffered major financial harm.

Government action

Governments are likely to shoulder the blame for causing recessions, while they also enact measures and implement strategies aimed at containing the economic damage and improving the situation. The Bank of Canada (BoC), an independent Crown corporation, has the power to stimulate the economy (as it did during the COVID-19 pandemic by reducing interest rates to help businesses stay afloat) or to combat skyrocketing inflation by increasing its policy interest rate, as it did from March 2022 to July 2023.

Raising interest rates, especially if done aggressively, can cool down the spending that fuels higher inflation. This was the approach the BoC took when it raised the overnight interest rate 10 separate times over 15 months to drive the rate of inflation down towards the bank’s target range of two to three per cent. Although that target has recently been achieved, the BoC has continually held its overnight rate steady at five per cent for nearly a year.[3] 

However, rapidly rising interest rates also have the power to send the economy into recession. With the highest inflation rate seen in Canada in almost 40 years[4] and the highest interest rates in over 20,[5] people are spending more to pay down their mortgages and loans, leaving less money on the table for other essentials. From the central bank’s perspective, the goal is to bring the supply and demand relationship back onto a more equal footing.

Manulife Bank’s semi-annual Financial Health Survey, published in November 2023, found that 84 per cent of Canadians thought the country was either already experiencing a recession or would head into one in 2024.[6] However, another late-2023 survey found that 25 per cent of Canadian respondents weren’t worried about a recession this year, up from only 15 per cent in a survey the year before.[7] The decline indicates that more Canadians are aware of the continued resilience of the economy, which in their mind, makes it less probable that a recession will occur in 2024.

Looking backward and forward

To formally declare a recession requires a great deal of calculation and consideration. Simply suggesting the likelihood of a recession can create anxiety for people, businesses and the economy overall. At the same time, some economic factors, such as inflation, can become so severe that a recession becomes a necessary remedy to help the economy gain a more comfortable foothold. In any case, recessions do happen from time to time and judging from history, are often followed by periods of healthy financial growth.

As long as the prospect of a recession remains a realistic possibility, preparing for it in advance could be a wise financial move. That’s why it’s so important to work with an advisor who can help determine the best strategies to support your short- and long-term goals – and to protect you from economic uncertainty.

[1] Average inflation rate and bank rate in Canada from January 2018 to November 2023 - Statista
[2] Bank of Canada interest rate - wowa.ca
[3] Average inflation rate and bank rate in Canada from January 2018 to November 2023 - Statista
[4] Canada inflation rate 1960-2024 - Macrotrends
[5] Canada interest rate - Trading Economics
[6] Financial Health Survey, Fall 2023 - Manulife Bank
[7] Number of Canadians worried about a recession drops from last year - BNN Bloomberg  

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