Recession may strike despite Canada’s low unemployment rate

In July, Canada’s unemployment rate held steady at 4.9 per cent, matching the historic low recorded in June and leading some to suggest Canada is safe from a recession. But while low unemployment potentially indicates a tight labour market, it doesn’t preclude a recession.

First, the unemployment rate can decrease for two reasons—either potential workers are finding work, which is positive, or potential workers are dropping out of the labour force and no longer looking for work, which is usually negative. While the unemployment rate was unchanged from June to July, there was a small decline in the labour force and small increase in the number of unemployed Canadians. All this to say, the unemployment rate is more complex than it may appear.

The unemployment rate is also a lagging indicator, meaning that changes in the rate tend to show up sometime after an economic downturn has already begun.

For example, imagine you’re a businessowner. As the economy starts to slow, your sales decline. The normal response is to reduce costs not directly tied to production and marketing. Bonuses might also be cut, but you generally try to avoid laying off workers who you’ve invested in and trained. As the slowdown continues and sales further drop, you may reduce worker hours but still try to avoid actual layoffs. Eventually, you may be forced to let go workers but it will normally happen much later in the recession, which is why the unemployment rate has traditionally lagged the economy by anywhere between six and 12 months and therefore is not the best indicator of how well the economy is performing. Simply put, today’s record-low rate may look very different sometime in the future when the economic downturn finally forces employers to act.

And by other important statistics, Canada’s labour market isn’t as strong as it may first appear. Generally speaking, a lower employment rate (not to be confused with the unemployment rate) indicates a smaller share of the working-age population is working. A recent study published by the Fraser Institute found that the overall employment rate hasn’t recovered to 2019 levels (pre-COVID). And in the past two months, Canadian employment levels have actually fallen even further.

In addition to the complicated labour market, there are other important measures to consider when assessing the risk of a recession.

Consider inflation—the topic on everyone’s mind. Year-over-year inflation was 7.6 per cent in July (the latest month of available data), following 8.1 per cent in June. Higher inflation makes the price of goods and services more expensive, putting pressure on household budgets because wage gains are insufficient to offset the increase in prices. When Canadians aren’t able to spend as much, there’s less economic activity and growth.

In an effort to combat inflation, the Bank of Canada hiked its benchmark interest rate by a full percentage point in July, the largest increase in more than 20 years. This was the fourth time the Bank raised interest rates since March and more rate hikes are likely on the way. Higher interest rates increase the cost of borrowing, reduce demand and ultimately slow the economy.

There are already signs the economy is cooling. Following a 0.3 per cent expansion in April, the Canadian economy experienced no growth in May and is expected to grow just 0.1 per cent growth in June. Not exactly encouraging numbers.

A record low unemployment rate is good news, but it’s just one indicator of the state of our economy. Despite Canada’s tight labour market, we could be headed for a recession.