{"id":26341,"date":"2024-11-19T08:00:26","date_gmt":"2024-11-19T13:00:26","guid":{"rendered":"https:\/\/www.construction.com\/?post_type=blog&p=26341"},"modified":"2024-11-18T14:16:06","modified_gmt":"2024-11-18T19:16:06","slug":"bumpy-road-to-recovery-for-the-canadian-economy-and-implications-for-its-construction-industry","status":"publish","type":"blog","link":"https:\/\/www.construction.com\/blog\/bumpy-road-to-recovery-for-the-canadian-economy-and-implications-for-its-construction-industry\/","title":{"rendered":"Bumpy Road to Recovery for the Canadian Economy and Implications for Its Construction Industry"},"content":{"rendered":"

by Arsene Aka, Senior Economist at Dodge Construction Network<\/em><\/p>\n

Despite recent mixed economic news, the Canadian economy is poised to rebound in 2025. This post describes the country\u2019s macroeconomic outlook and its implications for the construction sector in 2024-25.\u00a0\u00a0<\/span><\/i>\u00a0<\/span><\/p>\n

Recent Economic Developments Are Mixed<\/span><\/b>\u00a0<\/span><\/p>\n

After contracting during the pandemic, the Canadian economy has yet to return to pre-pandemic trend. The pace of economic growth accelerated to a seasonally adjusted annual rate of 2.1% in the second quarter of 2024, from 1.8% three months earlier and a modicum 0.1% in the last quarter of 2023. In the second quarter, the economy was lifted by higher household spending on services, government consumption spending and business investment in structures. On the other hand, exports, residential construction and household spending on goods fell during the quarter. The combination of modest economic expansions and strong population growth has led to successive decreases in GDP per capita over the last several quarters. GDP per capita fell 0.1% in the second quarter, its fifth consecutive quarterly decline.\u00a0<\/span>\u00a0<\/span><\/p>\n

\"Fig1\"<\/p>\n

The Canadian economy is expected to advance at a moderate pace in the fourth quarter and will end 2024 at levels that are still below the pre-pandemic trend (Dodge Construction Network computed pre-pandemic trends using output data from Q1-2010 to Q1-2020). The output gap (i.e., the difference between current GDP levels and pre-pandemic trend) stood at 2% in the second quarter. Though the gap is smaller than the 4% posted in the second quarter of 2021, it has widened since second quarter 2022, suggesting strong headwinds (e.g., low productivity) on the road to recovery.\u00a0<\/span>\u00a0<\/span><\/p>\n

\"Fig2\"\u00a0<\/span><\/p>\n

Because of potential impacts on investment flows between the two countries and their currencies, monetary policy from the Bank of Canada (BoC) and the U.S. Federal Reserve tend to move in lockstep. At the onset of the COVID-19 pandemic, the Fed delivered two large rate cuts at unscheduled emergency meetings in March 2020, lowering the federal funds target rate from 2.00% to the range of 0.00% – 0.25%. The Bank of Canada also moved three times that month to lower the target overnight rate to 0.25% and provide support to the economy. Two years later, both central banks began raising their key policy interest rates amid strengthening inflationary pressures.\u00a0<\/span>\u00a0<\/span><\/p>\n

In 2024, inflation began to ease in both countries and move closer to the central banks\u2019 targets. This allowed the Bank of Canada to kick off the monetary easing cycle with a quarter-point reduction in June. The monetary authority further reduced its policy interest rate in July (25 basis points), September (25 bps) and October (50 bps). In total the Bank of Canada has lowered rates by 125 basis points since June. On the other hand, the U.S. Fed has cut its policy rate by 75 bps only once thus far in 2024.\u00a0<\/span>\u00a0<\/span><\/p>\n

\"Fig3\"<\/span><\/b>\u00a0<\/span><\/p>\n

As noted, the rapid succession of rate cuts by the Bank of Canada has been facilitated by the strong moderation in inflation over the last several months. Inflation, as measured by the Consumer Price Index (CPI), has posted successive monthly declines since June 2024. Headline CPI inflation slowed in September to its smallest gain since February 2021. The CPI rose 1.6% year-over-year (y\/y) in September on a not-seasonally-adjusted basis, down from 2% in August, on the back of lower gasoline prices. A year earlier, inflation was twice as high at 3.8% y\/y. Rental prices\u2014which account for 30% of the CPI basket\u2014increased at a slower pace in September.\u00a0<\/span>\u00a0<\/span><\/p>\n

Meanwhile, the BoC\u2019s preferred measures of core inflation (i.e., CPI-median and CPI-trim) were unchanged (on a y\/y basis) from the previous month, advancing 2.3-2.4% y\/y. Although they remain above the central bank\u2019s inflation target of 2%, they represent a significant decline from the 2.8-2.9% y\/y growth posted only four months earlier. As can be seen from Figure 4, the contributions to inflation of all components of the CPI index (other than shelter) have decelerated markedly over the last several months.<\/span>\u00a0<\/span><\/p>\n

\"Fig4\"<\/span><\/b><\/p>\n

The Canadian labor market has cooled noticeably over the past year, weighed down by high interest rates. As a result, job gains have been moderate in recent months, although they unexpectedly picked up in September 2024. In October, gains were again moderate at +14,500. Business, building and other support services (+29,000), accommodation and food services (+12,000) and educational services (+12,000) saw strong hiring in October.\u00a0<\/span>\u00a0<\/span><\/p>\n

On a regional basis, employment rose in Alberta (+13,000), British Columbia (+8,000), Quebec (+6,500), New Brunswick (+3,300), and Newfoundland and Labrador (+500). It decreased in the remaining five provinces (i.e., Prince Edward Island (-1,100), Manitoba (-1,300), Saskatchewan (-2,000), Nova Scotia (-2,100), and Ontario (-11,000)). The jobless rate was flat at 6.5% in October, following a decline of 0.1 percentage points in September. Youth unemployment rate remains very high, despite falling 0.7 percentage points to 12.8% in October.\u00a0<\/span>\u00a0<\/span><\/p>\n

\u00a0<\/span>\"Fig5\"<\/span><\/b><\/p>\n

The stubbornly high jobless rate prevailing over the past few years is not surprising, given the rapidly increasing population. In the past two years, the population increase in Canada, which has boosted the labor force, has mostly stemmed from an increase in non-permanent residents, that is an increase in international students, asylum seekers, and temporary workers.\u00a0<\/span>\u00a0<\/span><\/p>\n

\"Fig6\"<\/span><\/b><\/p>\n

To curb the increase in non-permanent residents as well as ease the domestic housing shortage and pressures on health care, the federal government has recently announced various policy changes. In January, the government announced it would set a cap on study permit approvals for most applicants outside Canada for the years 2024 and 2025 to reduce international student numbers back to 2022 levels. In September, the authorities announced a further reduction of new international study permits for 2025-26, which now includes previously exempt master\u2019s and doctoral students. According to an analysis by the Royal Bank of Canada (RBC), recent limits on international study permits will lead to an aging population over time, which in turn will lead to a declining labor force, lower federal and provincial government tax revenues, and higher healthcare costs and pension obligations.\u00a0<\/span>\u00a0<\/span><\/p>\n

Positive but Weak Macroeconomic Outlook<\/span><\/b>\u00a0<\/span><\/p>\n

Inflation is expected to continue to moderate in the short term, as shelter price growth begins to slow and macroeconomic conditions remain soft. Dodge Construction Network expects inflation to decelerate in 2024 and 2025, averaging less than 2% in 2025, down from a rate of almost 4% in 2023.<\/span>\u00a0<\/span><\/p>\n

Meanwhile, monetary policy is likely to ease next year. The Bank of Canada accelerated in October the pace of interest rate cuts with a 50-basis point reduction to the overnight rate to 3.75%. The monetary authority may lower interest rates by another 25 bps in December, should labor markets continue to be soft and economic growth continue to be moderate. Beginning next year Dodge expects the Bank of Canada to cut rates by 25 bps at alternating meetings until they reach a terminal equilibrium rate of 2.5% in late 2025. Given that risks to inflation look increasingly tilted to the downside of the central bank\u2019s 2% target, an aggressive 50-bps interest rate cut cannot be ruled out at the next meeting.<\/span>\u00a0<\/span><\/p>\n

As interest rates retreat, consumption will accelerate and lift GDP, which in turn will help boost hiring. The economy is expected to post below-trend growth of 1% for 2024 (Moody\u2019s Analytics estimate) due to lagged effects of restrictive monetary policy. Though annualized growth reached almost 2% in the first half of 2024, third-quarter GDP growth is expected to be soft, tracking at an annualized rate of 1%, according to various commercial and investment banks. Dodge expects economic growth will accelerate to 1.9% in 2025, closer to the long-run potential output growth of 2%.<\/span>\u00a0<\/span><\/p>\n

Despite recent curbs on non-permanent residents Dodge expects the robust labor supply growth will push the unemployment rate above 6% in both 2024 and 2025. Finally, Dodge expects the Canada-U.S. exchange rate to reach $1.32 CAD\/USD this year before falling to $1.28 CAD\/USD in 2025. Despite the anticipated appreciation against the U.S. dollar, the Canadian dollar is currently facing strong headwinds resulting from 1) wider interest rate differentials between the U.S. and Canada, which could lead to more investment inflows in the U.S., 2) lower crude oil exports from Canada to the U.S. when compared to 2023, and 3) trade uncertainties (i.e., potential higher tariffs) raised by the U.S. election (Canada sends the bulk of<\/span> its exports to the United States.)<\/span>\u00a0<\/span><\/p>\n

Residential Construction Poised to Recover<\/span><\/b>\u00a0<\/span><\/p>\n

Factors that will impact the residential housing market in the short and medium terms include housing affordability, the recent curb on non-permanent residents, and fiscal and monetary policy.\u00a0\u00a0<\/span>\u00a0<\/span><\/p>\n

Data published by the Canadian Central Bank show that housing affordability\u2014although remaining at its worst level in more than 25 years\u2014has slightly improved in the nation over the past two quarters. Its housing affordability index measures the share of disposable income that a typical household would put toward housing-related expenses (in Figure 7, the late 1990s and early to mid-2000s represent periods of peak affordability). Housing affordability is anticipated to improve gradually overtime for the following reasons:\u00a0<\/span>\u00a0<\/span><\/p>\n