Fires, Floods and a Strike Don’t Change the Story: Scotiabank’s Forecast Tables

• Weather-related events and the port strike are muddying the outlook but underlying growth dynamics suggest the economy is slowing gradually. A rebound from those disruptions is likely to provide a modest boost to growth in the later months of this year but will not alter the underlying path for the economy.

• After roughly accounting for these disturbances, we continue to expect a basically stalled economy for the next few quarters. We now expect growth of 1.2% this year followed by a small expansion of 0.7% next year. These outcomes would be well below our estimate of potential output and put downward pressure on inflation as a result.

• We are hopeful that the Bank of Canada is done raising rates, but core inflation measures remain stubbornly high. We expect a moderation of inflation but Governor Macklem will need to raise rates further if core inflation exceeds our forecasts. Given the stability of core inflation in recent months, the risks to the inflation outlook are definitely tilted to the upside, meaning that risks to the policy rate are also tilted in that direction.

A number of unusual and powerful factors have buffeted the Canadian economy through the summer. Wildfires affected most provinces for much of the last few months. Major flooding in a few areas had major impacts on economic activity in those areas. And of course, the strike at the Port of Vancouver had a major impact on trade. Each of these factors impact our ability to get a clear picture of how the economy evolved in the second and likely third quarter, but we remain of the view that the Canadian economy is gradually slowing and that activity will essentially stall over the next few quarters when looking through the impact of these temporary shocks. As a result, we now expect the Canadian economy to expand by 1.2% this year, below our last forecast of 1.7%. In 2024, the economy is expected to expand by a very modest 0.7%.

Assessing the impact of these weather-related disturbances and the strike is critical to the Bank of Canada. Governor Macklem has been looking for evidence that the economy is slowing as he fine tunes policy settings. It is impossible at this stage to have a firm view on the impact of these shocks. We know they had a sufficient drag on the economy in Q2 to lead to a decline in GDP. Under normal circumstances, our economy would rebound from temporary distortions in the quarter or two following the disturbance. That extent of that rebound, however, is very much clouded (no pun intended) by the July strike, and the wildfires impacting western Canada through much of August. We have reflected that in our view, held back growth in Q3 to incorporate these factors. Relative to our last forecast, the catch-up is more likely to be felt in the final quarter of the year.

To be very honest, we do not have a good read on the sum total of these impacts and their timing. Incoming data will provide key insights on that. August employment data, for instance, which showed a strong rebound in employment and hours suggests that things will completely rebound sooner than we currently think. The US economy is showing remarkable strength in the third quarter, which should see some that bleed into Canada in Q4 if historical relations hold. What is more important in our view is to assess the impact of expected growth on the Bank of Canada’s policy setting. Governor Macklem chose to keep rates steady in September owing to evidence that the economy is weakening, despite clear concern about the stubbornly elevated levels of core inflation.

Accepting the uncertainty around potential outcomes in the short-run outlook, we undertook to evaluate what growth profile might trigger another increase by the Bank of Canada, or alternatively what quarterly profile might cause an earlier cut in interest rates. Generally speaking, anything less than a 1.5% decline in GDP growth in Q3 (or equivalent spread out over Q3 and Q4) would not be cause for the BoC to advance the cuts we continue to foresee in 2024Q2. On the other hand, given the current level of inflation, a more modest positive surprise leading to a growth of 2.4% could force at least one other move by the BoC. Since our current view is growth of 0.7% in each of the next two quarters, that suggests that minor wiggles around our view would not be enough to force a change in path for the Bank of Canada.

It is a very different story on the inflation side. Though we expect core inflation to decelerate in coming months, Governor Macklem has very little ability to tolerate a rise in core inflation. A very small rise in core inflation, or if core inflation were to remain at current levels beyond this quarter, would force the Bank of Canada to raise its policy rate further. That remains the dominant concern in our view. While we expect rates to remain on hold at current levels until 2024Q2, that depends critically on a reduction in inflation. Given the stickiness of recent core inflation readings, this means risks are clearly tilted to the upside as they concern interest rates.