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Highlights

  • In September, more central banks are shifting gear to focus on downside economic growth risks.
  • Softening economic backdrop in Canada shows no signs of pausing. We updated our forecast to show softer output growth, higher unemployment rates this year and next, and a slower recovery after.
  • With inflation risks receding persistently, we think the BoC will have ample room to ease and anticipate them to leverage that to cut rates more aggressively to a lower terminal rate.
  • US forecast changes TBD…
  • More ECB cuts

Forecast changes

It is not without a reason that central banks are more explicitly targeting downside risks these days. Labour markets conditions are continuing to weaken in Canada and the U.S. with little indications of stopping. Even in the euro area and the UK where growth appeared to be much more robust earlier this year, conditions seem to be dwindling with early PMI readings dropping towards the end of the summer.

And as much as domestic demand has weakened from restrictive monetary policies, in Canada and to a lesser extent the U.S., supply has also been increasing via 1) easing of pandemic blockages and 2) an influx of labour supply from new immigration. That’s lessening the odds that inflation will pick back up.

Moreover, rate cuts have lowered debt servicing expenses for existing homeowners but they have largely failed to reignite housing demand for potential buyers, given atrocious affordability issues that are at play. Conditions have stagnated, rather than rebalanced and that’s where inflation risks still remain.

Still, the broader risk from weak consumer demand, especially per-capita basis now poses a bigger risk to the economic outlook. GDP per-capita looks to be contracting again in Q3. Soft demand has been translating to much slower hiring, with the unemployment climbing persistently higher and growth in disposable income slowing.

A larger, and prolonged softening in the labour market can be the make-or-brake for household finances, against the backdrop of a large swath of mortgages that are still set to renew at higher rates (than origination) in 2025 and 2026. Median mortgage debt payment will continue to rise. But will be for the most part manageable, unless homeowners all of a sudden becomes unemployed.

For now, we continue to expect moderate increases in the u-rate to a peak of xx%, which should limit the extent of the mortgage shock. Central banks should, however, start to consider more aggressive rate cuts to stick the landing before it’s too late – i.e. excess supply gets too large in the economy such that it drives inflation persistently below the 2% target. Interest rates after all are still in the restrictive zone.

  • Climatic conditions
  • Labour availability
  • Proximity and access to North American markets

Mexico has access to a large and productive labour force that will be challenging to replicate in Canada. Canadian greenhouse operators are actively exploring approaches to integrate the use of artificial intelligence (AI) in greenhouse operations to centralize data and optimize growing conditions in real-time. The use of AI and other efficiency disruptive technologies are not expected to replace humans, but can improve Canada’s competitiveness. Complementary to a productive labour force and favourable climatic growing conditions, Mexico has also benefitted from open and free trade with the U.S. supported earlier by the North American Free Trade Agreement (NAFTA) and now the Canada-United States-Mexico Agreement (CUSMA). Simultaneously, Mexico fostered investments in large scale greenhouse facilities, improving its competitiveness overtime in providing fresh produce year-round that can reliably fulfill the U.S. demand. However, a growing trade imbalance between the U.S. and Mexico on fresh fruits and vegetables means there is pressure within the U.S. to explore legislative options that support its fresh produce industry43.

  • Proximity and access to European markets
  • Regional concentration
  • Climatic conditions

Spain’s ability to scale centralized greenhouse production within a short period of time and optimize regional market access and trade is certainly a model to learn from. Centralization of production has enabled Spain to emerge as a greenhouse exporting leader. The southeast city of Almeria accounts for 72% of greenhouse vegetables in the country, spanning 98,000 acres—the largest concentration of greenhouses anywhere in the world44. Spurred from strategic development and a lack of land use planning, Almeria is a centralized hub market that accounts for more than 80% of Spain’s greenhouse vegetable exports to the European Union45. However, Almeria’s expansive network of greenhouses has created negative externalities for the environment and those working and living within the region, such as depletion and salinization of water supply and even changes to the microclimate of the region46. Mitigating negative impacts on local communities, pollution, and the workforce from expanding highly concentrated areas of greenhouse production requires an inclusive and strategic lens to planning and development.

  • Investment in decarbonization
  • Land-use efficiency
  • High-skilled labour matches hi-tech industry

The Netherlands has a head start over Canada in navigating the complex landscape of producing more on less land, while mitigating GHG emissions. The country has limited land availability and has set GHG targets specifically for the greenhouse sector of 1Mt CO2 eq reduction by 2030 from 2016 levels, primarily from reducing emissions from energy47. The Netherlands’ target is coupled with enabling mechanisms such as the Energy Efficiency in Greenhouse Horticulture scheme, Green Label greenhouse certification, and demonstration projects to promote knowledge development and exchange. Packaging GHG targets with mechanisms designed to support the sector to grow and innovate while transitioning to a low-carbon system is a model that could be replicated by governments in Canada through initiatives such as the Sustainable Agriculture Strategy.

Central Bank Current Policy Rate
(Latest Move)
Next move
BoC 4.25%
-25 bps in Sep/24
-25 bps
Oct/24
Fed 4.75-5.00%
-50 bps in Sep/24
-25 bps
Nov/24
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Central bank bias

Central Bank

Current Policy Rate
(Latest Move)

Next move

BoC

4.25%
-25 bps in Sep/24

-25 bps
Oct/24

September saw the BoC deliver a third consecutive rate cut as expected. That still leaves the overnight rate at ‘restrictive’ levels – particularly compared to a softening economic growth backdrop that’s expected to keep pushing inflation lower. Governor Macklem in his comments focused on those downside risks, opening the door for more aggressive easing. For now, we expect another 25-bps cut in October.

Fed

5.25-5.50%
0 bps in Jul/24

-25 bps
Sep/24

In his recent speech Fed Governor Waller spelled out the need for interest rates to be moving lower in order to preserve growth in the economy That cements expectations for a first 25-bps rate cut at the meeting next week. Beyond then, a gradual slowing in the labour market is expected to keep the Fed on the steady path of easing. We think they will cut by 25 bps in every meeting until March 2025 (inclusive).

BoE

5.00%
-25 bps in Aug/24

0 bps
Sep/24

Data releases in the U.K. since the first BoE rate cut in August have shown a healthy combination of solid momentum in output growth and more progress in cooling wage/domestic inflation. Real household spending in Q2 was still below levels a year ago but is set to rebound further given growth in real income over the last year. We hold our forecast that the BoE will cut rates once more this year in November.

ECB

3.75%
0 bps in Jul/24

-25 bps
Sep/24

With most ECB speakers’ endorsement, a second 25 bps rate cut in September from the central bank looks like a done deal. Focus will be on how the ECB guides future decisions especially amid mixed data prints on growth, labour markets and inflation. We think the central bank will maintain a meeting-by-meeting, data-dependent approach, and expect them to cut only once more this year in December.

RBA

4.35%
0 bps in Aug/24

0 bps
Sep/24

The soft Q2 GDP data showed an outright contraction in household spending which may bring some relief to the RBA in terms of rebalancing demand and supply and what that implies for inflation moving forward. Measures for key wage and underlying inflation have shown more signs of easing lately but remain too high. We continue to expect the RBA will lag the global easing cycle and start cutting later in 2025.

In our mailbox (where we explore interesting economic questions landed in our inbox):

  1. A ‘normalized’ Beveridge curve raises risks labour market deterioration in Canada could accelerate
  • The Canadian labour market has gone from a period of excess labour demand in 2022 (a very high ratio of job vacancies to available unemployed workers) to now a period of excess labour supply (job opening rate below, and unemployment rate above, pre-pandemic levels.)
  • The relationship between the job opening rate and the unemployment rate is often referred to as the Beveridge Curve. And it matters when thinking about current trends in labour markets. When the ratio of job vacancies to unemployment is very high, then declines in hiring demand (ie. lower job openings) don’t have as large an impact on unemployment rates – essentially a large share of job ads pulled from those high levels were never going to be filled anyway because of labour shortages.
  • Those sensitivities are different when the ratio of job openings to unemployment are low – from that point, the unemployment rate is more sensitive to decreases in the job openings rate (in technical terms, the Beveridge curve is steeper in periods of excess labour demand, and flatter in periods of excess labour supply). And a downtrend in job openings has shown no sign of slowing – still running more than 25% below year-ago levels.
  1. Going through the weeds for productivity and labour assumptions of our GDP forecast
  • The surge in population growth over the last two years is stretching the economy’s ability to keep up with new supply (for example, of homes and healthcare services). But it has also boosted GDP by adding x.x million new consumers to the economy. That increase in the number of consumers has kept total economy-wide output growing even as per-person output declines and the unemployment rate rises
  • Federal government plans to cut the number of non-permanent arrivals will significantly both GDP and potential GDP for the next three years, with downside risks if the government follows through on initial plans to reduce the number of non-permanent residents in Canada to 5% of the population over three years.
  • Our own base-case assumes those cuts are too large to be achieved – the share of NPRs has increased by almost a percentage point as a share of the population since the Federal Immigration minister initially floated the idea of a 5% target – but even the reductions we assume (to a 6% share from 7.3% currently) will reduce population growth to x.x% in 2025 from x.x% in 2024 and x.x% in 2023.
  • There has been speculation that the feds could also lower permanent resident arrivals for a time, which would add further downward pressure to population growth.
  • We wrote that the earlier surge in population essentially floated all boats – raising both demand in the economy and supply with little impact on measures that depend on the balance of the two, like the unemployment rate and inflation, or GDP on a per-capita basis. That would likely be true of lower population growth as well. A smaller population increase than we assume, would lower both GDP growth and potential GDP growth, but have less of an impact on per-capita output and would not significantly change our expectations for the unemployment rate

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