Canada’s unemployment rate is just the latest economic indicator flashing red. It climbed to 6.6 per cent last month. Excluding the volatile swings of the COVID era, that’s the highest it’s been since 2017.

And economists say the malaise in the jobs market is deepening.

“Layoffs are also rising under the surface. And a down-drift in job openings signals that hiring demand from businesses is still slowing,” wrote RBC’s deputy chief economist Nathan Janzen in a note to clients.

In fact, the whole economy is still slowing.

For more than two years, inflation has been the dominating feature on the landscape. The central bank took extraordinary measures to try to get price growth under control. It jacked up interest rates in an attempt to slow the economy.

And it worked. Canada’s GDP growth slowed to around zero, teetering on the edge of a contraction, but avoided slipping into an outright recession. Inflation is now firmly within the Bank of Canada’s preferred window of one to three per cent and within spitting distance of the bank’s target of two per cent.

Race to avoid a recession

The problem is, the economy has continued to weaken even though inflation is now largely under control.

Per capita GDP has been negative in seven of the last eight quarters. And the latest monthly numbers show any momentum gained at the start of the year is waning.

So, now the Bank of Canada is in a race against time. It’s hoping interest rate cuts can work their way into the economy before Canada slips into a recession. 

“With inflation getting closer to the target, we need to increasingly guard against the risk that the economy is too weak and inflation falls too much,” said Bank of Canada governor Tiff Macklem on Wednesday.

It generally takes about 18 months for changes in interest rates to fully work their way into the economy. The last interest rate increase came in July of 2023, so we still haven’t fully absorbed the economic impact of the rate hikes.

The central bank has cut three times this year. That’s the first time since the financial crisis in 2009 that the central bank cut rates three times in a row. Economists expect the bank will lower interest rates in October and again in December.

“For now, we look for the Bank to cut rates to 3.5 per cent by January, and then to three per cent by next June, but the risks tilt to the Bank going faster than that, and potentially further,” wrote BMO’s chief economist Douglas Porter in a note to clients.

The question is whether those cuts will work fast enough to stave off a recession.

“The Bank of Canada doesn’t have a lot of time to be honest,” says Tu Nguyen, an economist with RSM.

Will consumer spending decline?

She says the central bank waited too long to start cutting and now needs to cut steadily over the next year or so to keep the economy out of a recession.

Nguyen says the unemployment rate is rising largely because the economy isn’t adding enough jobs to keep up with population growth. The federal government has announced measures to curtail temporary foreign workers and some foreign students.

WATCH | Why is Canada’s unemployment rate creeping up?:

That may add balance to the labour market. But it will also have other consequences.

“The only reason the economy has stayed out of a recession is because of aggregate consumer spending,” says Nguyen. And that, she says, has been almost entirely driven by population growth.

“Now that we have fewer people coming in, does that mean that aggregate consumer spending is going to decline and does that lead to a recession?” she asks.

Rethinking the rate cut schedule

Royce Mendes, the managing director at Desjardins Capital Markets, says consumers have been squeezed for years by a double whammy of rising prices and increased borrowing costs.

Even as inflation comes to heel and rates begin to drop, those consumers are still struggling under the weight of a higher cost of living.

“There’s no doubt that people are devoting a lot more to shelter and other essentials than they were before. They probably have a lot less money to devote to the fun stuff,” Royce told CBC News.

There’s some economic theory working against the Bank of Canada as well, he said.

The so-called Sahm Rule is a historically reliable indicator of a recession. It states that if the three-month moving average of the unemployment rate rises half a percentage point from its low point in the previous 12 months, then the economy is in a downturn.

Mendes says the Sahm Rule also tells us where the unemployment rate is headed.

“If the unemployment rate rises 0.5 percentage points over the course of the year, it tends to rise another two per cent. It’s like a snowball effect. You want to stop that snowball effect, but if the snowball gets too big it becomes very difficult. So you want to nip this in the bud now,” he said.

So, many economists say the Bank of Canada will be forced to rethink its rate cutting schedule. Mendes says a steady stream of cuts may not be enough and that the central bank may have to start looking at bigger cuts of half a percentage point or more if the economy doesn’t show signs of improvement fast.