A 5% policy rate could trigger a recession, the Parliamentary Budget Officer has warned

Continuing to raise the policy rate in an attempt to curb inflation could trigger a recession, the Parliamentary Budget Officer (PBO) warned in a report released last Thursday.

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Under the “risk scenario” created by the PBO, the US Federal Reserve and the Bank of Canada continue to raise their key rates to 5.25% and 5%, respectively, in early 2023, before starting to lower rates in 2024.

In doing so, Canada’s real gross domestic product (GDP) will begin to decline by the end of 2022 and continue to contract in 2023, pushing the country into recession.

The economy will lose 177,000 jobs by the end of 2024, but the unemployment rate is forecast at 6.2%, down from 5.2% in October 2022.

“In our risk scenario, due to a slowdown in economic activity and an increase in interest rates in 2023 and 2024, the budget deficit will increase to $42.9 billion in 2023-2024 (1.5% of GDP) and $36.5 billion in 2024-2025 (1.3% of GDP”), the PBO also predicted.

The scenario represents a warning to politicians, argued Yves Giroux, the parliamentary budget officer.

“The scenario in today’s report is one of many. I emphasize that this is not a suggestion – it only shows one of the possible outcomes of a situation. Policymakers and international organizations have expressed concern about excessive monetary policy tightening, and today’s report assesses some of the potential economic and financial consequences,” he explained.

Note that the key rate is currently set at 3.75%, after a half-point increase on October 26. The next revision will be on December 7.