High interest rates bite
Activity slowed in 2023 as the impact of the Bank of Canada's aggressive rate hike campaign kicked in and should remain weak in 2024 as financial conditions are likely to remain restrictive. Households, whose debt represents around 182% of disposable income, are particularly sensitive to interest rate rises, and are likely to continue to limit their discretionary expenditures. As a result, the contribution of consumption (55% of GDP), already sluggish, is likely to remain lackluster. Population growth, driven mainly by immigration, is expected to remain strong, providing some support for demand. However, this demographic dynamism is accompanied by challenges, particularly in terms of housing. High interest rates should limit the contribution of business investment spending. While inflation should continue to moderate and is expected to return to the Bank of Canada's target range (1-3%) in 2024, the later should begin a rate-cutting cycle later this year. Household and business spending could therefore strengthen in the second half of the year, as pressures on their finances ease, even moderately. Monetary easing would also support residential investment, which has weakened over the past two years. Public spending should make a positive contribution, with most levels of government showing little inclination to reduce it. Relatively favorable terms of trade and commodity exports will mitigate the slowdown in activity.
Fiscal policy remains relatively tight
The federal budget deficit is expected to narrow only gradually in fiscal year 2024-25. Revenue growth is expected to be adversely affected by sluggish economic activity. Nevertheless, the federal authorities intend to reduce the deficit over the coming fiscal years in order to respect a fiscal anchor set at 1% of GDP by 2026-27. New spending will mainly involve commitments to boost housing supply, as well as support measures for the clean economy. Interest expense should continue to rise, reaching 1.8% of GDP by 2024/25. While the general government gross debt ratio is very high, notably after deducting the assets held by the Canada Pension Plan and the Quebec Pension Plan, the net debt ratio (47% of GDP) remains lower than that of its G7 peers. Moreover, it should stay on a downward trajectory.
Moderate energy prices in 2023 contributed to a widening current account deficit. In 2024, the current account deficit is expected to remain moderate. Spending by Canadian travelers abroad will again contribute to a deficit in the services account. The trade balance could record a slight surplus, with exports buoyed by sales of commodities, while imports growth will remain moderated by slow domestic demand. The surplus on investment income could moderate after a strong recovery in 2023. The deficit on the transfer account will remain marginal. Non-residents' purchases of Canadian financial assets should amply finance the deficit. Foreign debt, largely held by the financial sector (over 60%), is still high (close to 130% of GDP).
Trudeau’s government is struggling in opinion polls
Justin Trudeau (Liberal Party), Prime Minister since November 2015, was voted in to a second term of office following the snap federal elections of September 2021. The elections resulted in the formation of a minority government (158 seats out of 338), with the balance of power broadly unchanged from the previous legislature (2019-2021). 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 remains in place until October 2025. The likelihood that it will remain in place until then was strengthened after the Liberals delivered on certain NDP proposals, notably by introducing a national dental plan for low-income families. In this context, it is also unlikely that Mr. Trudeau will call an early election, with polls indicating that his popularity has taken a hit as a result of inflation and growing concerns about housing affordability. The government is expected to announce some measures in this area, but fiscal room for maneuver is likely to remain limited. The main opposition party with 117 seats, the Conservative Party led by Pierre Poilièvre, has made strong progress in the polls since mid-2023, allowing them to contemplate winning an absolute majority in 2025. However, the first-past-the-post electoral system means that small changes in popularity dynamics can result in a significant shift in the balance of power.
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.
Despite some divergences, the partnership with the US remains a strong axis of Canadian diplomatic relations. In contrast, relations with China have been strained in recent years. The investigation into possible Chinese interference in Canadian elections could further strain them in 2024. Government allegations that India was behind the assassination of a Sikh leader in British Columbia, which India has denied, have soured the bilateral relationship, and could jeopardize efforts to deepen diplomatic and economic ties between the two countries.