High interest rates threaten activity
In 2022, growth remained strong, driven by the positive impact of easing health restrictions and high commodity prices, especially energy. However, the effects of inflation and rapidly rising interest rates began to be felt towards the end of the year and are expected to further dampen activity in 2023. They will affect the contribution of private consumption (about 55% of GDP). On that score, Canadian households will be particularly vulnerable to rising borrowing costs given their very high debt levels. However, the savings accumulated during the pandemic (about 12% of GDP), a durably robust job market at the turn of the year (5.0% jobless rate in December 2022), expected moderation in inflation during the first half of the year, and population growth associated with strong immigration are likely to keep their spending afloat. Residential investment, which has already suffered from rising interest rates in 2022, is expected to continue to contract. Construction is likely to be affected in 2023.
Conversely, despite the adverse rate environment, high commodity prices, the energy transition, and infrastructure projects should keep private investment resilient. Energy and agricultural commodities (wheat) will continue to support export growth, but the sluggish US business outlook should weigh on manufactured goods exports. With provincial and federal governments ensuring that fiscal policy does not conflict with tight monetary policy, the contribution of government spending will be very limited. After raising its key interest rate by 425 basis points between March 2022 and January 2023, the Bank of Canada is expected to keep it at 4.5% in 2023. Energy, food and import prices are expected to fall, which should help contain inflationary pressures.
Prudent management of public finances
The budget deficit narrowed sharply in 2022 as a result of surging commodity prices, the recovery in activity and the reduction of pandemic-related support spending. The budget deficit is expected to remain low in 2023-24 as the federal government has indicated it intends to exercise fiscal prudence. Amid the inflationary context, measures to support purchasing power are primarily targeted at the lowest-income households. Government spending is also expected to be aimed at stimulating investment in clean technologies, such as the creation of a specific tax credit and the proposed launch of a Growth Fund. While debt servicing is expected to increase, it will remain below 2% of GDP. On the tax front, a new 2% tax on share buybacks is expected to be introduced in the 2023-24 budget and will contribute to revenue growth. However, revenues are expected to grow more slowly as activity slows. While the general government gross debt ratio is very high, the net debt ratio (47% of GDP) - especially after deducting the assets held by the Canada Pension Plan and the Quebec Pension Plan - remains lower than any of its G7 peers. Moreover, it is expected to continue trending downward.
Current account widens slightly
After narrowing sharply in the last two years in the wake of a trade balance that turned into a surplus, the current account deficit is expected to widen somewhat in 2023. Moderation in commodity prices, particularly energy prices, is expected to dent the balance of goods. In an environment of higher interest rates, the income account deficit is also expected to weaken. Spending by Canadian travelers abroad will again contribute to a deficit in the services account. The deficit in the transfer account will remain more insignificant. Non-residents' purchases of Canadian financial assets should more than finance the deficit. Foreign debt - largely private at about 80% - is still high, representing about 125% of GDP, but should stabilise.
Looking at the next election in 2024, the overall direction of the next parliament is very difficult to predict as the already fragmented political landscape is drifting even further apart. Flanders is veering increasingly to the right (VB together with the Flemish conservatives were the clear frontrunners in spring 2023) while Wallonia is tending to the left (PS is in the lead).
Trudeau government's stability bolstered by deal with NDP
Justin Trudeau (Liberal Party), who has been Prime Minister since November 2015, held on to his position following the early federal election of September 2021. The election resulted in a minority government (158 seats out of 338) with the balance of power broadly unchanged from the 2019 election. While no minority government has served a full term, a "confidence and support agreement" signed with the New Democratic Party (NDP, 25 seats) in March 2022 could ensure that Justin Trudeau's government continues until October 2025. Under the agreement, the NDP, led by Jagmeet Singh, will support key government initiatives and, in return, the government will advance NDP priorities, starting with dental and pharmacare programmes. The agreement is non-binding and therefore fragile and disagreements, particularly on social policy, could jeopardise it. The Prime Minister would be reluctant to call an early election as his party's popularity has eroded in favour of the Conservative Party on back of high inflation. The main opposition party with 117 seats is led by Pierre Poilièvre, who was elected leader in September 2022 to try to consolidate this advantage until the next general election. Sources of friction between the federal and provincial levels of government remain strong. The federal government has, for example, clashed with the Conservative governments of Alberta and Saskatchewan, which argue that federal climate policies have a negative impact on the oil and gas industry. There are also regular disagreements with the French-speaking province of Quebec.
Relations with the US, which were tense under Donald Trump, appear to be calmer under the Biden administration. Differences remain, however, on energy and trade policies.