S&P Global Ratings expects the Canadian economy to turn the corner in 2024 with a moderate rebound, following annualized growth of below 1% during each of the last three quarters of 2023. The pickup in growth momentum, albeit from a low base, was evident in 1.7% annualized growth in the first quarter, which was in line with our expectation. The rise in Q1 GDP was driven by the services sectors, exports, and a post-strike rebound in the public sector (see chart 1). Consumer growth led the way, and relatively strong retail sales in April as well as the uptick in consumer confidence in May point to a similar outcome in the second quarter.

We revised up GDP growth for this year by 20 bps to 1.1%. Domestic demand will rise by 1.05% this year, after contracting 0.07% in 2023.

The opening of the Trans Mountain Pipeline extension in May is an upside risk to GDP growth later in the quarter. But with the inventory-to-sales ratio at a decade-high, there is still a risk that an inventory drawdown will weigh on GDP growth.

We like to look at domestic demand for a real sense of the strength in the economy (see chart 2). We forecast that domestic demand on a fourth quarter over fourth quarter (Q4/Q4) basis--a measure that avoids statistical carry-over bias of typically reported "annual average"--will grow 1.6% in 2024 (compared with 0.4% in 2023), as quarterly annualized growth in the second half will average 1.9% (versus 1.2% in the first half).

Chart 1

Chart 2

While we are more positive about the economy going forward, most of the growth rebound in our forecast will come from fixed investment, rather than from consumer spending.

It is likely that the cumulative lagged effect of higher interest rates will continue to weigh on consumers. Even though the BoC has embarked on its new easing cycle, borrowing costs will remain much higher in the next two years than the pandemic lows. Part of it is due to the mortgage renewal system in Canada. With the upcoming five-year mortgage renewals bringing in higher interest-rate payments relative to 2020-2021 era contracts, many homeowners will see interest payments as a share of income rise in 2025 and 2026. Part of it is also because tighter immigration policy should curb the high aggregate consumption growth impulse relative to 2022 and 2023.

The rebound in growth will mainly come from fixed investment--both residential and non-residential investments. The monetary easing cycle that begun in June will help flip these investment outlays from contraction last year to expansion in our forecast horizon. It may not be gangbusters investment. Still, it is much needed to start ending the malaise of last several quarters. Spending plans outlined by the government in the recent budget season should also lend a helping hand this year and the next.

That said, aggregate outlays are still underperforming, especially on a per-capita basis. We see growth below potential through this year. That means employment growth is likely not going to keep up with labor force growth. Monthly employment growth dropped to 27,000 in May (from 90,400 in April), a little less than the six-month average gain of 34,000. Still, the unemployment rate jumped 0.4 percentage points in the last two months to 6.2% because of the surge in labor force. The unemployment rate has risen by 1.2 percentage points from the cycle low. The increase owes partly to a rise in the labor force--fueled by a rising immigrant population--as employment gains have also stuck below the pre-pandemic average.

Chart 3

The Business Outlook Survey shows weak net hiring intentions, which looks consistent with sluggish demand. This, combined with immigration-fueled labor force growth, suggest the unemployment rate will rise from the current level. As more people join the labor force, the unemployment rate is likely to increase to 6.4% on average in the second half of 2024, after averaging 5.4% last year. Wage growth eased to 5.0% year over year in May (from 5.7% in December), and we expect the trend to continue as the labor market loosens further.

Chart 4

At its June policy meeting, the BoC cut the overnight rate by 25 bps to 4.75%--its first cut of an easing cycle that will likely last through next year (see chart 3). The bank maintained its messaging stance that the path of inflation is the key factor in potential changes to its policy, even as the economy has weakened considerably. The BoC's preferred measures of core inflation (CPI-trim and CPI-median) surprised to the downside in the last four months. The average of core CPI-trim and CPI-median rose 0.1% month over month for a fourth month running, and is now under 3% on an annual basis. The above-target rate of headline inflation is entirely due to mortgage costs.

Chart 5

Chart 6

The ongoing pattern of weak consumer spending and labor market conditions supports our expectation for inflation to keep moderating in the quarters ahead. The Summary of Deliberations from the BoC's June meeting reiterated that further interest-rate cuts are likely but didn't give explicit guidance on how quickly the bank will ease further. With another two CPI releases before the July meeting, our sense is that the BoC will cut 25 bps again in late July, provided core inflation falls further, as we expect.

The BoC still has a shelter price problem, but we now assume the BoC will cut rates by 75 bps this year as it will look past shelter price inflation. We expect another 125 bps in rate cuts altogether next year to its long-run nominal neutral rate. With the BoC cutting, lower interest rates will cause mortgage-fueled inflation to plunge for the rest of the year. We anticipate the loony to depreciate more against the dollar this summer before it begins strengthening as the Fed's cuts come into view more explicitly. We expect the Fed to begin its easing in December with accelerated rate cuts of 100 bps and 125 bps in 2025 and 2026, respectively.