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Monthly Economic Letter

September 2020
Feature article

Assessing the economy six months into the pandemic

While lockdowns have been eased, the outlook remains uncertain

In this month’s letter, we examine the impact of the pandemic on the Canadian economy as the magnitude of the initial shock is now measurable.

We also share our expectations for the next six months. The economy still faces multiple challenges and a vaccine for the coronavirus will be necessary, but not sufficient, for a full recovery.

The economic impact—six months after the great lockdown

In the face of the unknown, the early months of the pandemic were marked by sweeping restrictions aimed at limiting the spread of the virus.

The economic impact of these measures was immediate. One in six Canadians lost their jobs between February and April (three million jobs lost). City centres around the world were emptied, industrial production slowed sharply and retail sales fell to an unprecedented low.

The most recent data from Statistics Canada shows the magnitude of the economic shock. In the first half of the year, the economy contracted by 13.4% compared to the fourth quarter of 2019.

However, since May, activity has picked up again and points to a rebound in GDP that would bring economic activity in September back to about 95% of its pre-crisis level. (See the Canada section.)

By August, 63% of the jobs lost during the lockdowns had been recovered. But not surprisingly, the most affected sectors remained accommodation and food services (21% fewer jobs) and information, culture and recreation (13%). These two industries depend on proximity to customers and an influx of tourists, who have been largely absent in 2020.

While the economy has performed mostly as expected, there have been some surprises. A V-shaped recovery—a rapid return to pre-crisis GDP—remains out of the question for the Canadian economy as a whole, but retail sales have exceeded expectations and even set a record in June.

These results are mainly attributable to the significant income support measures put in place by various levels of government, and consumers catching up on purchases that could not be made during the lockdowns.

Nevertheless, the economy remains in a severe recession with permanent job losses. Although it’s operating at close to 95% of its capacity, compared to 82% in April, the coming period is likely to be more difficult.

The expected scorecard for Year 1 of the COVID-19 era

In the absence of a second wave, the economy will continue to grow over the next six months, but at a much slower pace.

Despite increased confidence since the easing of the distancing measures, business investment intentions remain weak. According to our internal surveys, many entrepreneurs are focused on shoring up their finances as they emerge from the crisis. Investments will be delayed even longer in the hard-hit oil-producing provinces. (See oil section.)

Meanwhile, exports were down 8% in July compared to the pace observed in 2019. Several factors will continue to impact Canadian exporters, including low oil prices, uncertainty caused by tensions between the U.S. and China, and more generally, increased protectionism by several trading partners.

Finally, the gradual withdrawal of government support programs will have an impact on household disposable income, which has so far remained buoyant during the crisis.

Caution by consumers that’s reflected in a higher savings rate could lead to a slowdown in retail sales. In addition, physical distancing measures will limit the recovery potential of several sectors. It is unlikely that these measures will be further relaxed until a vaccine is developed and distributed. In the graph, the closer to 100, the more stringent are distancing measures. It shows that Canada’s current standing compares to the United States and is stricter than much of Europe.

Currently, we are forecasting a contraction of the Canadian economy of about 7% in 2020. This implies that the momentum observed over the summer will fade this fall.

Underlying risks remain significant

The strength of the recovery will depend on how two key risks play out.

  • In the short term, will a second wave of infections occur?
  • In the medium term, will a vaccine be deployed and how effective will it be?

In the short term

Our baseline scenario assumes Canada will escape a second wave of infections. However, a severe second wave would lead to a W-shaped recovery, where the economy would contract again in a few months’ time.

The reintroduction of lockdowns as stringent as the ones in effect last spring remains unlikely. However, a tightening of physical distancing measures would lead to further setbacks in several sectors, as demonstrated by the situation in some U.S. states.

A mushrooming number of cases is currently being reported in several European countries, including France and Spain. Thus, a partial lockdown remains a definite downside risk for Canadian entrepreneurs.

In the medium term

The full recovery of the global economy will require the development of a vaccine against COVID-19 that would likely be available in 2021. Several potential vaccines are currently in late-stage development.

However, there will still be many challenges to returning to a full-employment economy like the one we had before the pandemic began.

A vaccine is never 100% effective and the longevity of the immunity period would remain uncertain. Additionally, the production and distribution of a vaccine will be an unprecedented operation, suggesting it may run up against numerous bottlenecks.

Thus, a vaccine is necessary but not sufficient for an economic recovery. It is therefore likely the economic impact of COVID-19 will persist for some time to come. As things stand, outbreaks of infection could be part of our reality until 2022.

What does it mean for entrepreneurs?

  1. The recovery is progressing well and the number of cases of infection remains stable for the moment.
  2. However, the increase in infections in Europe shows the fragility of the situation. Canada could experience a second wave in the coming months.
  3. Lockdowns as stringent as those in the spring are unlikely. However, business owners operating in service sectors with close physical proximity (e.g. accommodation and food services) should have a contingency plan to deal with the possibility of a tightening of measures to counter the spread of the virus.
  4. The development of a vaccine will not be enough to erase the economic damage done by COVID-19. Entrepreneurs need to keep an eye on their cash flow.
  5. According to our surveys, many companies have bet on a strategy of minimizing costs and increasing efficiency. With the economy still nearly two years away from full recovery, it may be useful to follow their lead by reviewing your business processes to remain competitive.
Canadian economy at a glance

The recovery is well under way

Canadian economy rebounded this summer from the damage caused by the pandemic

The historic 11.5% contraction in Canadian GDP in the second quarter has been much in headlines in recent weeks.

The drop, which corresponds to an annualized decline of 38.7%, was larger than that observed in the United States (-31.7%), but less than France (-44.8%) and Britain (-59.9%). In general, the duration and severity of lockdowns explain the differences.

However, even as the GDP was falling in Canada, the personal savings rate rose to 28.2% in the second quarter, thanks to government aid programs that more than compensated for lost wages. At the same time, disposable income increased by 10.8% over its first quarter level.

This household purchasing power set the stage for a rebound in retail sales at the end of the second quarter. What's more, higher savings could support consumption in the months ahead.

For Canadian entrepreneurs, the extent of the economic disaster caused by the pandemic was already known. What was surprising and important was the economy’s momentum in the past few months.

After an 18% GDP contraction during the lockdowns, the Canadian economy had made up half of the lost ground by June, a month when the recovery was particularly robust (6%).

Preliminary estimates from Statistics Canada suggest GDP growth of 3% in July. That would bring Canada to within 6% of its level of economic output at the beginning of the year. GDP is expected to grow by nearly 7% (30% annualized) in the third quarter, followed by a significant slowdown in the fourth quarter.

While impressive, the recovery remains uneven across sectors. In June, construction was operating at 96% of its level at the beginning of the year, but manufacturing was struggling at 88% of its pre-crisis level. (See table.)

The situation was much worse in several service sectors, including transportation and warehousing (74%) and arts, entertainment and recreation (41%). The re-opening of restaurants in some provinces helped the accommodation and food services sector rebound, but it remained at only 55% of its normal level of activity.

These sectors will be among the last to return to their previous levels of activity.

V-shaped recovery in the labour market is coming to an end

In August the labour market improved for the fourth month in a row. An additional 246,000 Canadians were employed, so that 1.9 of the three million jobs lost during the lockdowns had been regained. Not surprisingly, the sectors still struggling were those facing the most severe health restrictions—the arts, accommodation and food services.

Unfortunately, the job recovery already seems to be losing steam with the unemployment rate set to remain high (10.2 per cent). In line with GDP growth, which is expected to start slowing soon, we expect a much slower recovery in job creation in the coming quarters.

We forecast it will take until the second half of 2022 for employment to return to pre-crisis levels. The yellow line in the graph below illustrates this recovery. (The dotted portion is a projection.) It shows the current recovery will be slower than the one following the 2008-2009 financial crisis but faster than the recessions of the 1980s and 1990s.

Resilience of retail sales and the housing market

This month’s main article reports that retail sales have returned to pre-pandemic levels. The scale of government programs has played an important role in this recovery. However in the months ahead, the disappearance of gains from pent-up demand and a slow recovery in the labour market may limit the sector's performance.

The resilience of housing starts is even more surprising. Leaving aside the month of April, when the sector was at a standstill in Quebec, the vigour of the last few years is continuing, despite uncertainty about the direction of the pandemic. After seven months, housing starts are holding at the same pace as in 2019, surpassing the 200,000 annualized rate.

However, we expect a slowdown in residential construction over the next two years. Disposable income is expected to decline and gains in the labour market will be more limited. Demographic factors will be the main driver of residential activity over the medium term.

Sharp slowdown in immigration

Closed borders have limited the entry of newcomers into Canada. During the April to June period, 34,260 permanent residents were admitted, compared to 94,275 in 2019, a 64% drop. Immigration has been an important engine of economic growth for Canada, with the influx of new residents accounting for most of population growth in recent years. In a context of an aging population and skilled labour shortages, immigration has contributed to Canada's economic resilience in a variety of ways, including by sustaining strong labour and housing markets and even contributing to Canada's competitiveness in technology sectors.

A prolonged slowdown in immigration could weaken Canada's overall competitiveness. At the end of the COVID crisis, it’s possible labour shortages may still be a reality for Canadian entrepreneurs.

What does this mean for entrepreneurs?

  1. The strong recovery in recent months has come as a welcome relief in an extremely difficult year. However, it’s likely the summer pace of economic reopening will fade. The gradual withdrawal of various government programs will also limit the growth of household incomes.
  2. As a result, consumers will remain cautious until they learn more about the evolution of the pandemic. Their price sensitivity is likely to increase over the next few quarters. Therefore, competing on price could pay dividends.
  3. If your industry has been experiencing labour shortages in recent years, it’s possible this problem will remain a reality following the recovery. It would be wise to take this into account when making staffing decisions.
U.S. economy at a glance

U.S. recovery expected to slow down

The economy picked up during the summer, despite a resurgence of infections in several states

The U.S. labour market continued to recover, with the housing and retail markets being particularly strong. However, some indicators are showing signs of weakening and point to a slowdown ahead this fall.

Employment as a harbinger of a slower recovery

The contraction of GDP in the second quarter was slightly revised from minus 32.9% to minus 31.7% (annualized). Despite this incredible drop, U.S. GDP is now expected to be 5% lower for the year as a whole.

Employment is improving as 1.4 million Americans returned to work in August, bringing the cumulative job loss to 11.1 million in 2020. As a result, the unemployment rate fell to 8.4%, its lowest level since the beginning of the pandemic (3.5% in February). The labour force participation rate also gained ground, rising to 61.7% in August.

However, the pace of job creation was significantly slower than that observed from May to July (a recovery of 3 million jobs per month). This slower pace is likely to persist as evidenced by the 6.2 million individuals reporting temporary layoffs in August compared to 18.1 million in April.

Another statistic to monitor is the number of repeat claims for unemployment. While weekly enrolments remained around one million, there were still close to 15 million Americans renewing their unemployment benefits every week in August. As time passes, these job losses will be harder to recoup in the short to medium term.

Income support set to decline

Consumption remained strong, with retail sales reaching a new high in July. This situation seems contradictory as the economy is operating well below potential and several million Americans remain unemployed.

However, it’s mainly due to the unprecedented income support measures offered by the government. A massive stimulus package, combined with enhanced unemployment benefits, helped raise the household income of a majority of Americans. In total, it went from $19 trillion (annualized) pre-crisis to more than $20 trillion, up 5% over the summer (10% during the lockdowns).

This financial boost more than compensated for the loss of work income (see graph). Some of this income was saved, particularly among better-off households—the overall savings rate was 18% in July. The rest was used, among other things, to support consumption.

This financial support even had an impact on the new home sales market, where the 901,000 transactions recorded in July was the highest since 2007.

Future government assistance is, however, more uncertain. The U.S. Congress was unable to agree on the terms of a new unemployment insurance assistance plan to replace the one that expired on July 31.

A renewal of this support at $300 per week, instead of the $600 per week granted since April, has been suggested. Meanwhile, administrative delays by states could worsen the situation further. In any case, household income is expected to decline over the next few months.

Confidence indices show contradictory signs

Business confidence increased over the summer, according to the Institute for Supply Management.

The ISM Manufacturing Index rose to 56, a peak since 2018 (an indicator above 50 indicates expansion in the sector). New orders were particularly strong as firms renewed inventories. The indicator for firms in the service sector declined slightly to 56.9.

For both indices, the employment component scored less than 50, suggesting a limited outlook for labour market gains in the coming months.

Among consumers, the trends are less encouraging. The Conference Board Index posted no gains over the summer and remained at a low point dating back to 2014.

Uncertainty related to unemployment insurance, and more generally the prospects for controlling the pandemic and its impact on the economy, are likely to undermine a return of consumer confidence. The situation could eventually weigh on consumption and, consequently, on the economy.

What this means for Canada

  1. The U.S. recovery is entering a stage similar to the one underway in Canada—a slowdown means the economy will take some time to return to its potential.
  2. Declining household income and anemic consumer confidence pose a risk to U.S. consumption.
  3. This weakness in consumption, combined with the recent depreciation of the U.S. dollar, could put a damper on Canadian exports.
Oil market update

A quiet summer on oil markets gives way to a less predictable fall

Oil prices have remained stable since June thanks to a fragile market balance

Volatile oil prices in the first months of 2020 gave way to a welcome but uneasy period of stability this summer.

Oil production increased somewhat in July, but analysts also predicted slackening demand to the end of 2021. Therefore, it will take inventories, which remain high, longer to clear than previously anticipated—several quarters at least.

Canadian oil held steady at around US$30 per barrel

In the context of a partial reopening of industrialized economies, oil traded at stable prices during the summer.

West Texas Intermediate (WTI), the North American benchmark, traded in a narrow range of $40 to $43 per barrel. (All figures in U.S. dollars.) Western Canadian Select (WCS) was similarly stable, in the $29 to $33 range.

However, the spread between these prices has increased in recent months from $8 to nearly $12 per barrel, reflecting some additional logistical constraints for Canadian producers. For example, limited capacity on the Enbridge Mainline at the end of July hampered the potential for crude oil exports to the United States.

Demand remains constrained with a less mobile population

According to the International Energy Agency (IEA), demand for oil was weaker than expected this summer in North America, Japan and the United Kingdom, despite the gradual reopening of these economies.

Google's community mobility reports, which measure the movement of users of its Android services, indicate that mobility in Canada changed little this summer, while it was up very slightly in Europe. Mobility was on average 20% lower than before the pandemic in Canada. Since the data are not seasonally adjusted and people tend to travel more during the summer months (especially in a country with harsh winters), travel remains lower than at the coldest time last winter.

As the fall approaches, there are still many uncertainties. The end of summer vacations and the beginning of the new school year have led to a surge of COVID-19 infections in the United States and some European countries in recent weeks. (See main article.)

Since demand for jet fuel will remain weak for the next few quarters (until late 2021 according to the IEA), demand in industrialized countries will rely almost entirely on ground transportation.

It seems certain, at least in Canada, that the approximately 40% of employees who can work from home (see this Statistics Canada study) will continue to do so until at least the end of 2020 and more likely well into 2021.

Also taking into account the coming drop in gasoline demand in the northern hemisphere, the increase globally may depend more on a strong recovery in China and an improvement in the situation in developing countries that continue to struggle to control the pandemic.

Slight supply increase from OPEC+ and North American producers

Oil supply increased slightly in July after reaching a near 10-year low in June. It remains below estimated global demand and inventories would have decreased slightly over the summer. Inventories had almost reached full-storage capacity earlier in the spring after they increased by more than 20 million barrels per day (mb/d) in April. They would have declined by about 2 mb/d since June.

The increase in supply was generalized among all producers. OPEC+, for its part, revised its production targets upwards in August by 2 mb/d. In the United States and Canada, prices are considered favorable for an increase in production, which should nevertheless remain below its level of recent years.

Drilling activity suggests a rebound in production in Canada. At the beginning of September, there were 54 drilling rigs in operation. While this is up from the lows of the second quarter (13 to 25 in May and June), it’s far lower than the 150 to 230 rigs in operation between 2017 and 2019.

Low prices to continue to crimp oil-producing regions

For oil-producing provinces, low prices will continue to weigh on their economic dynamism for some time to come.

The price stability of recent months can be explained by a wait-and-see attitude among investors on two aspects. First, demand for oil remains on the rise thanks to the resumption of mobility in the West and the strength of industrial production in China. However, the potential impact of a second wave of COVID-19 infections remains uncertain, even if it only leads to partial lockdowns.

Second, the markets want to see evidence of sustainable cooperation between oil-producing countries after a price war broke out last March between Russia and Saudi Arabia.

Supply and demand thus remain in a fragile balance. The high level of international inventories could, in our opinion, lead to a drop in prices in the last few months of 2020.

Nevertheless, if price levels were to be maintained, Canadian production could increase by 10% over the next few quarters, reaching 5.5 mb/d—the 2018-2019 average level, according to the IEA.

Still, current prices are not high enough to encourage new investment projects in either the U.S. or Canada. This underlines the importance for oil-producing provinces to further diversify their economies.

Other economic indicators

The Bank of Canada’s quantitative easing continues

The Bank of Canada’s Monetary Policy Report, released in July, contained the central bank's first estimates of the size of the economic shock caused by the pandemic.

After contracting by 7.8% in 2020, the bank expects GDP growth of 5.1% in 2021 and 3.7% in 2022. This would mean the economy’s output gap would be closed only by the end of 2022. Our projections are slightly more optimistic but are in the same direction.

While interest rates are likely to remain at the lower end of their range for a few more years, the central bank continued its asset purchase program, which totalled $543 billion at the end of July. This program aims to stimulate the economy and ensure the good functioning of markets. It’s expected to continue until at least 2021 and will help keep long-term interest rates low.

Appreciation of the Canadian dollar

This summer, the loonie continued to rise, reaching US$0.76 for the first time since mid-January.

This appreciation was mainly due to the U.S. dollar's underperformance against major international currencies in response to the Federal Reserve’s suggestion that the current ultra-accommodating monetary policy would be maintained for a prolonged period of time. As well, investors were less inclined to seek refuge in the dollar as a safe haven than was the case at the beginning of the pandemic.

Trend in business confidence remains encouraging

Entrepreneurs remained optimistic in August as CFIB's Business Barometer Index edged down slightly to 59.2. The manufacturing index was up and also in expansionary territory at 56.8. An index above 50 indicates that most entrepreneurs expect their business situation to improve in the coming months.

As of September 3, 64% of businesses were "fully open," compared to 53% at the end of June. However, only 41% of small and medium-sized businesses had rehired their entire staff and only 28% were reporting a normal level of sales.

Only one sector—natural resources—was still contracting. The stability of oil prices should lead to increased optimism in the energy sector in the coming months, but it’s clear that many industry participants still fear another price drop. (See the oil section).

Inflation remains below target

Inflation decelerated between June and July, as the annual rate of price growth slowed from 0.7% to 0.1%. The average of the Bank of Canada's three core indexes, which put more emphasis on the less volatile components of the standard consumer basket, decreased from 1.7% to 1.6%.

Some components grew at a faster pace, including food (+2.2%) and shelter (+1.5%). Prices for clothing and footwear were 2% lower compared with the summer of 2019, while the recreation, education and reading component showed an even sharper decline of 4%.

Weak demand caused by the pandemic is expected to keep the inflation rate below the Bank of Canada's 2% target until the end of 2022, according to the Monetary Policy Report.

Key indicators—Canada