Parliamentary budget officer projects considerably slower economy, declining federal deficit

OTTAWA -

The parliamentary budget officer is projecting the economy will slow considerably in the second half of 2022 and remain weak next year as the Bank of Canada continues to raise interest rates.

In his latest economic and fiscal outlook released Thursday, budget watchdog Yves Giroux said he expects the Bank of Canada to raise its key interest rate to four per cent by the end of the year, a move which is in line with financial markets' expectations.

Economists are anticipating an economic slowdown as higher interest rates slow spending by people and businesses.

Since March, the Bank of Canada has raised its key interest rate from 0.25 per cent to 3.25 per cent in an effort to combat inflation. Canada's annual inflation rate was 7.0 per cent in August.

The housing market has already begun cooling in response to higher interest rates, but the full effect of the central bank's rate hikes will take more time to work its way through the economy.

The PBO report also projects the unemployment rate will rise to 5.8 per cent by late 2023 before falling again. That increase is moderated by decreases in the labour force participation rate as more Canadians retire.

Statistics Canada's September job report showed the labour market was still tight, with the unemployment rate at 5.2 per cent.

As inflation slows and heads toward the central bank's target of two per cent, the PBO expects the Bank of Canada to begin lowering interest rates toward the end of next year, bringing its key rate down to 2.5 per cent by the end of 2024.

The outlook also estimates the federal deficit will decline to $25.8 billion, or 0.9 per cent of GDP, for the 2022-23 fiscal year.

The deficit was $97 billion, or 3.9 per cent of GDP, during the prior fiscal year.

Assuming no new measures are introduced and existing temporary measures expire as expected, the PBO estimates the deficit will decline further to $3.1 billion, or 0.1 per cent of GDP, by 2027-28.

The PBO's latest deficit projection is lower than what it had forecast in March, largely due to tax revenues being higher than anticipated.

The PBO is also projecting that by 2027-28, the federal debt-to-GDP ratio will decline from its peak in 2020-21, but still remain above pre-pandemic levels.

The report said that as interest rates rise, the debt service ratio, which is public debt charges relative to tax revenues, will peak at 11.5 per cent in 2024-25 before declining gradually.

The PBO said the uncertainty surrounding the report's projections is high. It outlined various risks to its forecasts, including tighter monetary policy causing a more severe economic slowdown, inflation persisting longer than expected and higher fiscal spending.

"With the synchronized tightening of monetary policy by major central banks around the world to reduce high inflation, there is a risk of a more severe global slowdown, which would negatively affect the Canadian economy and federal finances," Giroux said.

This report by The Canadian Press was first published Oct. 13, 2022.