December 2, 2022

Inflation will fall swiftly next year and Canada will narrowly avoid a recession, Goldman Sachs says in a new – and overall quite upbeat – outlook for the country in 2023.

The outlook, contained in a report authored by senior economist Daan Struyven and managing director Sid Bhushan, also predicts further pressure on housing – but with prices ultimately stabilizing to above levels prior to the pandemic. Part of the reason is that the U.S. banking giant believes the Bank of Canada is nearing the end of its interest rate hiking cycle, though not before a further 75 basis points in interest rate hikes by early next year.

Goldman sees Canadian housing prices ultimately falling 18 per cent from their peak in February. They’ve already fallen 10 per cent, based on MLS Home Price Index data up until October. That means if the bank’s views turn out to be correct, prices will be subject to a further drop of eight percentage points before flatlining and possibly rising once again.

The bank sees headline Canadian inflation falling to 2.8 per cent by next December. That would be down significantly from the last reading of 6.9 per cent in October. Here are some highlights of the report:

• “Inflation appears to be making genuine progress, and the housing market – the largest vulnerability – is making a controlled descent. We expect the BoC to achieve a soft (enough) landing in 2023.”
• “We expect below-trend +0.7% Q4/Q4 growth in 2023 and think Canada will narrowly avoid a recession because growth momentum is stronger than it appeared a few months ago, the negative impulses from financial conditions and real income growth have likely bottomed, excess savings can cushion negative housing wealth effects, and structural demand should support residential investment. If there is a recession, it would most likely be mild.”
• “We are also confident that recent improvements in inflation will be sustained and forecast 2.8% year-over-year headline inflation in December 2023. We expect falling house prices to weigh on shelter inflation and for sequential core goods inflation to remain soft. In fact, we expect sequential ex. food, energy, and mortgage interest cost inflation to be below 2% by next summer. Further, we think that both wage-sensitive services and goods inflation would need to materially surprise for sequential core inflation to be above 3% at this point.”
• “As a result, we believe the BoC will stop hiking soon. We expect another 50bp hike in December as growth is holding up, BoC-preferred core inflation measures edged up in October, and the BoC likely wants to see more labor market rebalancing. We expect a final 25bp hike in January for a 4½% terminal rate but see a high risk that the cycle ends in December even if the BoC hikes 50bp then.”
• “We do not expect any BoC cuts next year. Even in a resilient growth environment, the market may continue to price cuts as underlying sequential inflation pressures weaken. We think the BoC will look through this as growth should be picking up and some negative inflation impulses should be fading at this point, but the risk of a cut is higher than in other G10 economies.”
• “The main risk to our soft landing forecast is a more severe housing downturn. However, we are not too worried about this risk yet because sequential house price declines are getting smaller, strong demand from high population growth should absorb new constructions, and the risk of mortgage delinquencies is low. We now expect an 18% peak-to-trough decline in house prices because downward momentum remains strong, mortgage rates have risen sharply and valuations remain stretched, and because the large number of houses under construction should boost supply next year. That said, the level of house prices should remain above its pre-pandemic trend at the end of next year because of high inflation, elevated nominal wage growth, and because housing supply will still not be loose by historical standards even after accounting for the better supply outlook.”

Source Credit: The Globe & Mail Writer Credit: Darcy Keith @eyeonequities