David Rosenberg: Tighter immigration targets could tip Bank of Canada rate below 2%

Article content

By David Rosenberg and Dylan Smith

The beleaguered Justin Trudeau government is finally pumping the brakes on its immigration targets after presiding over the biggest population inflow surge since the post-Second World War boom. 

Compared to the prior aggressive targets, this will mean slower labour force growth and hopefully stem the relentless multi-year erosion in real gross domestic product (GDP) per capita because it has become abundantly clear that Canada’s economic infrastructure has been insufficient in absorbing the unprecedented wave of international immigration inflows these past three years.

Article content

What is this shift in policy, exactly? The updated three-year targets have Canada welcoming 390,000 new permanent residents in 2025, down from 500,000 in 2024, with similar adjustments to the targets for 2026 and 2027. But the real change comes with the introduction of targets for temporary residents for the first time, which has accounted for the majority of the immigrant-led population boom in recent years (Canada has averaged 573,000 net arrivals per year over the past seven years, topping out at 1.2 million in 2023). 

There are currently more than three million temporary residents in Canada — over seven per cent of the population. The new targets aim to reduce that figure to five per cent, which is a huge shock over a short time frame. Since a large share of the permanent residency target will be allocated to temporary residents currently in Canada, the net flow of new arrivals and overall population growth will turn slightly negative for two years.

Let’s unpack what this means for the economy. The effect on the labour market appears straightforward at face value. The labour force will grow at a slower pace, implying a tighter labour market than would otherwise be the case. But a bit of context is necessary here: the labour force has been growing much faster than employment over the past year (2.7 per cent year over year compared to 1.8 per cent in the latest data), leading to a 0.9 percentage point rise in the unemployment rate to 6.5 per cent over the past year. 

Article content

Article content

We need to consider what will happen to both quantities under the new plan. Yes, labour force growth will be slower, but it will likely still be positive (from students acquiring permanent residence and job-focused economic migration being given a higher priority than before). At the same time, slower immigration implies a significant hit to labour demand due to the impact on aggregate growth and consumption. So, the direction of travel of the unemployment rate compared to the previous is not necessarily much changed, maybe only a little slower to loosen on the margin.

In essence, with the ranks of the joblessness having expanded by 20 per cent over the past year, there is already a ton of idle labour for businesses to tap into, even after the immigration curbs go into effect. The unemployment rate won’t necessarily be lower as a result of this policy change because the labour market is already oversaturated.

While one can lay claim that in the counterfactual, this is “inflationary” from a wage perspective (fewer immigrant inflows competing for jobs), there is an offset because reduced immigration targets will also have a suppressing impact on aggregate demand growth. So, this all comes out as a wash for Bank of Canada policy, and governor Tiff Macklem has already said as much in the recent past.

Article content

Putting these economic interactions together, it’s clear that the adjusted targets will not pause the Bank of Canada’s rapid easing path and, as a result, we are not inclined to make any adjustments to our long bonds/short loonie call in Canada. If anything, the impact on demand is very likely to be far more important than the supply-side effects, basically fuelling more disinflation and driving the central bank into an even more accommodative posture.

From an inflation perspective, the implications of stemming the immigration tide are straightforward: fewer arrivals means lower inflation.

Consumption growth is directly proportional to population, so there will be a tailing off in price pressures on consumer goods and services demand, especially in “hot” migration-related items (furnishings, clothing, basic goods). Housing is another important inflation aspect: the population surge has been an important driver of Canada’s housing bubble and is the reason rental inflation is still running at eight per cent year over year.

The Government of Canada estimates its new policy will close the housing gap (the number of units required to bring the housing market into balance) by 670,000 units by 2027 (positive, but only a dent in Canada Mortgage and Housing Corp.’s estimated gap of 3.5 million by 2030). Nonetheless, the impact of the adjusted targets on rental markets will undoubtedly be disinflationary considering that the main drivers of lower immigration will be the substantial drop in new arrivals to Canada (who tend to rent while they look for permanent accommodation) and students. 

Article content

With the headline consumer price index currently running at 1.6 per cent year over year, a normalization of the rental market would take it almost down to one per cent, and that’s before you model in other shelter costs and the drop in consumer goods demand. A sustained target undershoot and even outright deflation is now a meaningful risk on the horizon for the Bank of Canada.

The impact of the new policy on growth is perhaps the most consequential. Changes in population growth will affect the size of the economic pie as well as its distribution, and both matter a lot. A major complaint about the Canadian economy of late has been the decline in real per-capita GDP at a rate of around minus two per cent year over year, which is a function of the population growth of more than three per cent year over year outstripping real GDP growth of around one per cent.

But the next issue is what happens with real GDP growth outright. That is trending near a one per cent annual rate, far below any estimate of potential growth — risking a prolonged environment of excess supply — two words in the latest Bank of Canada post-meeting press release that were mentioned not once, nor twice, but three times. And this, in turn, means that, if anything, the risks for at least 2025 and 2026 will be one of ongoing disinflation or perhaps even deflation. 

Article content

It must be emphasized that immigrant-fuelled population growth has been the source of aggregate GDP growth over the past year because new arrivals spend money setting up shop in Canada, gain employment and start consuming locally or spend remittances from abroad (in the case of students). It’s likely that a three percentage point drop in population growth strips more than one percentage point off aggregate demand, triggering an outright recession, all else being equal. Again, this feeds into our dovish Bank of Canada policy forecast.

One other development to consider is that these reduced immigration targets are more likely to cause a reduction in the so-called “neutral” interest rate (the Bank of Canada currently estimates the midpoint to be 2.75 per cent). All of a sudden, getting to “neutral” or even below that level is likely going to be an even longer row to hoe for the central bank than was the case prior to these altered immigration targets. Not only that, but we estimate it will take at least two or perhaps three years before any inflationary supply side developments begin to overtake the depressing demand-growth implications. 

Article content

As such, our call that the policy rate dives to two per cent or even lower than that before the easing cycle ends is fully intact — indeed, it’s emboldened by these new immigration targets. Since the terminal rate being embedded in the financial markets is around 2.75 per cent, then, if our assumptions prove to be prescient, a bleak Canadian dollar outlook becomes ever bleaker (heading to 66 cents U.S.), and there remains value across the Government of Canada bond curve.

David Rosenberg is founder and president of independent research firm Rosenberg Research & Associates Inc. Dylan Smith is a senior economist there. To receive more of David Rosenberg’s insights and analysis, you can sign up for a complimentary, one-month trial on the Rosenberg Research website.

Bookmark our website and support our journalism: Don’t miss the business news you need to know — add financialpost.com to your bookmarks and sign up for our newsletters here.

Article content