Big six bank has below-consensus inflation forecast and explains economic downturn strategy
Pointing to June 2022 as the peak in North America, Eric Lascelles, Chief Economist at RBC, says the beginning of 2023 sees the four main drivers of record-level inflation beginning to lose momentum. But although these changes precipitate a corresponding — albeit slow — drop, the descent will be anything but smooth.
“There will be some choppiness as we are still dealing with things like rapid wage growth,” Lascelles says. “But inflation likely can fall more than the market is currently assuming, and that's a fairly big deal. Inflation's been the biggest problem over the last year.”
As supply chains improve significantly, commodity prices fall substantially, central banks move beyond stimulative mode into outright restrictive mode, and businesses begin to change their pricing behaviour, inflation is starting to fall and RBC is projecting a below-consensus inflation forecast. However, there are still “far more economic headwinds than tailwinds,” Lascelles says, and RBC is also forecasting a recession for the developed world in 2023. Europe and U.K. will likely fare worse overall due to Russian sanctions, particularly high natural gas prices, and the political turmoil in the U.K., and he sees Canada’s more rate-sensitive economy shrinking more than the U.S., mostly due to its exposure in an overheated housing market.
Already facing affordability concerns pre-pandemic, prices soared throughout the COVID period and rising mortgage rates have worsened the situation. Housing resales are falling, new build plans are being pushed out, and home prices are declining, pointing to even further housing weakness as the year progresses. However, Canadian mortgage market rules make it unlikely that the 2008 experience will repeat and immigration numbers should provide some support for demand.
Lascelles calls it a tricky time as governments will likely want to provide some support during the next downturn but face high borrowing costs and a less tolerant bond market. Structurally, RBC predicts this will be an era of big government as energy subsidies roll out, pressure to increase military spending in a more dangerous geopolitical world intensifies, spending obligations for aging populations rise, green spending expands, and there’s more spending on industrial policy as deglobalization marches forward.
“The story is one in which governments would like to spend a lot bond markets don't want them to — It could be interesting,” Lascelles says. “At a minimum, there should be more differentiation between well-behaved and poorly-behaved sovereigns.”
Once again, it’s not all bad news as the anticipated recession could be more useful than usual: it would tame inflation — job one, Lascelles notes — and should also help right-size housing markets as well as cool what is arguably an unsustainable labour market. It will likely feel milder than it is because RBC doesn’t expect to see job losses on the scale of past recessions given companies are motivated to keep the workers they’ve recently worked hard to bring aboard.
“It's also worth recognizing recessions are not forever. They last a few quarters, and in this particular case, we think it actually sets up growth for a fairly robust period of expansion over the subsequent several years,” Lascelles says. “And classically, there are also good investment opportunities that arise during economic downturns and indeed the valuations that we see today are already at least partially reflecting that.”
