Economic Forecast 2024: A Cross-Border Outlook on Interest Rates, Inflation, Housing and More

In an October presentation, RBC economist Carrie Freestone offered insights on what 2024 may bring. Addressing consumer spending, labour markets, GDP growth and inflation, Freestone shared her interpretation of these and other key indicators and what they may mean for Canadian and U.S. residents.

A global picture

Freestone reports that global GDP growth slowed in 2023, and a further slowdown is expected into 2024. “This is the case in most major economies that we monitor,” she says, adding that higher interest rates are beginning to impact consumers around the world, affecting spending and economic growth.

While Canadian GDP growth is mirroring the global picture, the U.S. is an outlier. In fact, GDP growth has been excessively strong south of the border in the first three quarters of 2023. But Freestone doesn’t expect the momentum to continue, as American spending has been fuelled by pandemic savings, which have now largely been depleted.

A recessionary environment in Canada — and eventually in the U.S.

GDP data shows that Canada is currently in a mild recession but isn’t expected to be severe this year or next. Freestone expects a “mild to moderate” recession through 2024 due to the slowdown of the economy and a quieting of Canadian spending.

While Q1 2023 recorded quarter-over-quarter GDP growth of 2.6%, Q2 was quite a bit softer, seeing a two-tenths decline in quarter-over-quarter GDP — a decline that prompted the recession call earlier in the year.

So, how is Canada avoiding a more severe recession? Freestone credits the country’s population growth, which sets the Canadian economy apart from other economies.

“The Canadian population grew by 3% last year. Over the past decade, Canada’s population has grown faster than China, India, the U.S., Central and South America and Europe,” explains Freestone.

How does this population growth impact the economic outlook going into 2024? Freestone explains:

• It’s distorting some of the numbers: For instance, even though the unemployment rate is rising, new jobs and new people filling jobs are driving labour growth.

• It’s masking per capita decline: As the population grows significantly and more and more people come in, they’re spending more — even if Canadians are starting to spend less than a year ago. “We have record numbers of immigrants and non-permanent residents coming to Canada, working and studying here on a temporary basis. And these people are spending money,” says Freestone. “It’s kind of keeping us afloat.” While real GDP growth has been declining since the back half of last year, Canada has been doing well on an aggregate basis. “Population growth is part of what will insulate us from a more pronounced recession.”

In day-to-day life, Canadian households are feeling the squeeze

Today, Canadians are spending 15% of their take-home pay on servicing their debt. Grocery inflation is close to 7% year-over-year, and wages aren’t growing fast enough to keep up with all these added expenses. As a result, there is evident consumer pullback on spending regarding discretionary goods. “Canadians are squeezed,” Freestone says.

“On top of paying more for groceries and more for gas, we are starting to see a pullback on the services side as well,” says Freestone. Higher debt payments and inflation will further reduce Canadian purchasing power and weaken retail sales. Freestone adds that she expects things will improve in the back half of 2024 as Canada emerges from the recession and rate cuts start to take place, but it will take some time for those cuts to filter through the broader economy and have an impact on consumption.

Interest rates: where they’ve been and where they’re going next

Before diving into the current state and future forecast of interest rates, Freestone shares the drivers of the rate hikes of the past year:

• At the peak of the pandemic, real GDP contracted by more than 18% and 3 million jobs were lost in Canada, leading to a 13% unemployment rate. Since labour data has been tracked, the rate has never been this high.

• The economy recovered quickly — as of November 2021, all the jobs lost during the pandemic were fully recovered, and Canada even started to gain jobs.

• At this point, demand was at record highs in Canada. Canadians were willing to pay higher costs from lumber to concert tickets to restaurants, airfare and hotels due to pent-up demand.

• In February 2022, Russia invaded Ukraine, eliminating a large portion of the European oil supply and severely constraining the global wheat supply. Commodity prices soared higher.

• Once the Bank of Canada determined inflation was not transitory, it began raising interest rates to contain inflation. Going back to last year, the Bank of Canada raised rates 10 times by 475 basis points.

“We’re coming off a decade between the financial crisis and the pandemic where interest rates were around 1% — well below the target level of 2%,” says Freestone. “In the pandemic, they were at a quarter of a percent. And now we’re sitting at 5%. So that’s a significant shock,” she continues, adding that mortgage rates have risen drastically as a result, causing people to feel the pinch.

Where will rates go from here?

Freestone points out that the Bank of Canada and the U.S. Federal Reserve are mindful of the risks of over-increasing rates, as there is typically a 12-month lag between the time rates are raised and consumers feel the impact. “This is why our expectation is for the Bank of Canada and the Fed to keep interest rates at the 5% range,” she says. “If they hike too high – and we won’t really start to feel the impact until next year – the debt servicing ratio will continue to rise.” In other words, higher interest rates could pull economies into a more serious recession.

“We’re at the point now where more and more Canadians are renewing their mortgages. In the U.S., it’s a little different because people have longer-term mortgages than in Canada. But as people are starting to renew their mortgages, we’re seeing that people are starting to be a bit more constrained. So our base case is for the Bank and the Fed to keep rates where they are.”

What does this mean for inflation and the economic forecast in Canada?

Interest rate increases are meant to curb the rate of inflation. “The Bank of Canada’s target range is 1-3%,” explains Freestone. “We really want inflation to get to 2% — the closer we get to three, there’s a sign that monetary policy has been working.”

In July, inflation was sitting at 3.3%, which is closer to the target, but in August, headline inflation trended higher and reached 4%. One month does not make a trend, and if higher prices in August could be reversed in September, the outlook would be better. As of Freestone’s presentation, September inflation data had yet to come in.

What does this mean for inflation and the economic forecast in the U.S.?

South of the border, inflation is still above target but coming down a little faster than in Canada. From a consumer perspective, one significant difference is that grocery prices in the U.S. are reportedly up 3% year over year — while in Canada, they’re up 6.9%. In the country’s services sector, inflation is closer to the target at 2.2%.

The big question is, when will rates start to come down? “I hate to break it to you, but we don’t expect cuts in Canada until Q3,” says Freestone. We think the Bank of Canada will cut rates by 50 basis points in Q3 of 2024 and another 50 basis points in the fourth quarter. So that will bring the overnight rates to 4% by the end of 2024 – still well above the previous neutral level of 2%, but coming down from 5%.”

In the U.S., where hikes were a little higher, Freestone shares that the expectation is a 25 basis point cut in Q2 and then — like in Canada — a 50 basis point cut in Q3 and another 50 basis point cut in the back half of the year.

The impact of labour markets

The Bank of Canada and the Fed are concerned about the tightening labour market. Freestone explains why this matters:

“When the unemployment rate is low (last summer in Canada, it was at a record low at 4.9%), employers can’t find staff. And when employers struggle to find staff, prospective employees demand higher wages. So labour shortages fuel wage growth, which can also be inflationary.”

“We have seen the unemployment rate rise from 5% to 5.5%, and we expect it will continue to go up and peak at the end of this year at 6.6%,” shares Freestone. While the unemployment rate is trending upward, she is keeping an eye on wage growth. “If wages are rising and just keeping up with inflation, that’s fine. The concern is when wage growth starts to exceed the rate of inflation. We’re in a situation where it’s still higher. We want it to cool off a bit, and it hasn’t yet, so that’s something that we’re going to be monitoring.”

Housing markets are softening in Canada and the U.S.

The housing markets bottomed out on both sides of the border in the spring of 2023. Most markets have rebalanced but are still soft. As Freestone reports, Canada’s price growth has recently reached its slowest pace — the MLS Home Price Index (HPI) only rose by about four-tenths of a percent from July to August. “Things are still pretty weak right now, but once we start to see cuts next year, we expect the market will pick up a bit.”

Freestone adds that many are asking why the Canadian market has not experienced a more pronounced crash. The answer is population growth. “As long as more people are moving to Canada, the question is, can we build enough housing? The answer to that is no — we are not building nearly enough housing for all the people that are moving here.”

She reports that this is very concerning for housing affordability in Toronto, where the median income required to service a five-year fixed-rate mortgage with a 25-year amortization period is roughly 80% of a homeowner’s take-home pay. In Vancouver, it’s 98%. Housing will continue to be a challenge for prospective buyers.

Freestone admits, however, that this demand is a good thing if you’re a homeowner. “If you own Canadian property and you want to cash out and move to the States, you’re in a good spot right now.”

Outlook for the U.S. dollar

Freestone concludes with a look at the U.S. dollar. The USD has strengthened against the CAD over the last year, which is driven more by global investors gravitating to the U.S. dollar than a weakening of the Loonie. “As rates have risen globally, people tend to buy more U.S. dollars,” says Freestone, adding that the current higher yield environment (driven by multiple factors including interest rates, inflation and an upcoming U.S. election and) attracts money from investors abroad, pushing the U.S. dollar higher.

This year, Freestone expects one CAD will be worth roughly 72 cents USD. Next year, the expectation is for it to reach 76 cents. “Things will improve, but it’s going to take some time.”

The bottom line

While Canada finds itself in a mild recession, population growth, strong savings behaviours and a rising unemployment rate may be insulating the country from a more severe recession. The Bank of Canada and the Fed have strategies to help keep inflation at bay, but the expectation is that rates will hold steady and may even come down towards the end of next year. While there appears to be cause for optimism and relief, Freestone says, “It’s going to take some time.”

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