Monthly Economic Letter

October 2021
Feature article

Get ready for more pressure to raise wages

Inflation and labour shortages have been the subject of much discussion lately. Many observers are concerned an inflationary spiral is developing in Canada and for good reason. The pressure for higher wages due to labour shortages is already being felt by many entrepreneurs. Where will wages go next year and what impact will they have on the economy and your business?

Demand for labour is increasing, wages will follow

There’s no doubt bargaining power is now in the hands of workers. According to a recent BDC study, 30% of companies are having difficulty hiring new employees because the salaries they offer are lower than what’s expected by potential candidates.

In a time of labour shortages, salaries are a key factor for entrepreneurs. Beyond being important in hiring, they are also central to a company’s ability to retain its current employees.

Nearly six out of 10 employees who plan to change jobs in the next year are doing so because they want a higher salary. Considering the costs associated with hiring new employees and the increasing competition for labour, entrepreneurs are increasingly inclined to pay more.

How big will wage increases be in 2022?

Excluding companies that intend to freeze salaries, employers forecast an average increase of 2.7% for 2022, according to a LifeWorks study. This is the highest annual growth expectation in the last five years.

Additionally, only 3.3% of companies say they intend to freeze wages in 2022, the lowest level in the past five years. Of course, because of the uncertainty, many firms froze salaries during the pandemic—36% in 2020 and 12% in 2021.

Not surprisingly, it appears that provinces with the most acute labour shortages will experience the largest wage increases. The same goes for industries that are experiencing rapid economic recovery, such as information technology and construction.

The wholesale industry is the sector that will see the highest wage growth in 2022, according to forecasts. The opening of Amazon fulfillment centres across Canada may have pushed other wholesalers to increase salaries to remain competitive.

Considerably higher wages are also expected in the restaurant and accommodation sectors where the workforce has been severely affected by pandemic shutdowns. These sectors are experiencing particularly acute labour needs because many employees have moved to other sectors as a result of the closures.

The impact of the pandemic

It’s difficult to get a clear picture of the current state of wages in the country. At the start of the pandemic, Canada lost nearly 3 million jobs. At that time, the average wage jumped 10% in April and May 2020 on a year-over-year basis. This increase didn’t reflect wage increases, but rather the loss of many low-paying jobs during the early stages of the pandemic.

Since then, many workers have returned to their positions. Employment was back to its pre-pandemic level in September, but its composition has changed. The average weekly wage in the country was 107% of its February 2020 level and remains well above the long-term trend estimate. When maintaining the 2019 job composition by occupation and tenure, average hourly wages increased by 4.6 percent in September 2021 compared to the same period two years ago.

While the BDC survey found that 49% of SMEs have already increased wages to address labour shortages in recent months, it is likely many workers will seek higher salaries in the months to come.

The cost of doing business is rising

An acceleration in wage growth could contribute to increased inflationary pressures. In addition to intentions to increase spending on employee wages, companies have been dealing with higher input costs for some time.

Without solid productivity gains, the profit margins of many SMEs will not be able to absorb these rising costs for long.

Inflation could, therefore, continue to exceed the Bank of Canada's target range next year. With workers seeing their purchasing power shrinking and being well aware of the labour issues in the country, it wouldn’t be surprising to see wage pressure ratchet higher over the next year.

The impact on your business

  • Be prepared to increase salaries and offer more benefits to employees, especially if you operate in an industry where workers are in high demand.
  • Look to improve your operational efficiency to reduce your input costs to offset increased labour expenses.
  • Invest in technology and training to improve your company's productivity and competitiveness.
Canadian economy at a glance

Reopening the economy brings challenges

As we enter the fourth and final quarter of 2021, a number of challenges, including labour issues, will limit growth in Canada. The economy is expected to continue to grow, but the gains will be more moderate than what had been anticipated at the beginning of the year.

A difficult start to the third quarter

Economic activity stumbled in July, as GDP fell 0.1%, following a 0.6% increase in June. However, preliminary analysis from Statistics Canada indicates that growth resumed as the summer wore on.

StatsCan currently estimates that GDP grew by 0.7% in August. The economy would thus have been running at 98.8% of its pre-pandemic pace.

The good news is that the July decline turned out to be less severe than expected.

An uneven recovery

The accommodation and food services sector was particularly strong, growing by 12.5% as restaurants and bars continued to reopen across the country. The story was similar for the arts, entertainment and recreation sectors, where activity rose 8.1%, the highest monthly growth for the sector in a year.

However, the rebound in these industries was not enough to offset challenges faced by other major sectors of the economy.

Three major sectors that are now struggling to grow

The real estate sector accounts for 13% of Canadian gross domestic product. The sector recovered quickly from the crisis, regaining its pre-pandemic level of activity by July 2020 after having lost only 5% at the height of the crisis.

Activity in the resale housing market produced a strong recovery in early 2021, but the supply of homes for sale has been drying up a little more each month.

After three consecutive months of losses, growth was again anemic for the sector in July. With home sales declining further in August, the prospects for future gains are dim.

Elsewhere, the trade sector (retail and wholesale) accounts for 10% of the Canadian economy. The industry recovered from a 26% loss in activity between April and September 2020 and proved resilient in the face of the second and third COVID waves.

However, this summer's reopenings allowed many Canadians to travel and reduced their spending on home renovation projects. Thus, the demand for building materials decreased and with it the price of lumber. This is reflected in sales of lumber by wholesalers (-12.4%) and retailers (-7.3%) in July.

Canadian manufacturing is another big contributor to GDP, accounting for 10% of output. Here, volatility and the adverse effects of the pandemic continue to affect the sector's outlook.

While auto production rebounded in July from June as a result of plant reopenings, the forestry industry and sawmills are now struggling.

Additionally, it’s becoming increasingly clear that supply cannot keep pace with demand as the industry continues to face numerous challenges. Shipments of manufactured goods contracted by 1.7% net of inflation in July.

A domino effect of made in China

An energy crisis is currently raging in Asia, particularly in China where energy is becoming increasingly scarce. Factories are being forced to close in order to conserve energy in certain provinces of the country. China is one of the most important suppliers of intermediate goods to Canada and the slowdown in Chinese manufacturing could have a negative impact on Canada.

The closure of Chinese factories and ports to curb the further spread of COVID-19 in the country was already an issue for the global economy. Now that factories are temporarily shutting down to meet regional energy needs, it’s likely supply problems will increase during the rest of the year. New shortages could emerge and increase inflationary pressures.

Employment gains will be hard to come by

In September, the economy added 157,000 jobs and the unemployment rate fell from 7.1 percent to 6.9 percent. This means that employment has fully recovered to its pre-crisis level. However, considering the increase in population, the employment rate is still below what it was in February 2020.

Labour shortages are intensifying in many provinces and industries. As a result, employment gains will prove increasingly difficult to achieve.

The impact on your business

  • The full reopening of the Canadian economy (with a few exceptions) is creating a new dynamic. The restaurant and hospitality sectors are getting busier, while other industries, which were doing well at the beginning of the recovery, are now slowing down. It's the swing of the pendulum and a step closer to a new reality for the Canadian economy.
  • Supply difficulties are putting pressure on production costs and manufacturers are unable to keep up with demand. China's energy crisis could exacerbate supply problems. If you are dealing with China, try to place your orders early in anticipation of long lead times.
  • Labour issues remain the No. 1 challenge for Canadian companies and will continue to be for a long time. Learn how to deal with them in the latest BDC study on labour shortages.
U.S. economy at a glance

Headwinds are getting stronger

The U.S. economy has so far experienced a solid recovery. Gross domestic product grew 6.6% in the second quarter. The economy is expected to continue to perform well in the second half of the year but at a more modest pace.

Uncertainty is mounting over the Biden administration's stimulus plans, wrangling over raising the debt ceiling and labour shortages.

A new source of uncertainty

For once in more than 18 months, COVID is not the leading source of uncertainty in the economy. Instead, the culprit is raising the U.S. government’s debt ceiling, an issue that comes up from time to time.

According to Treasury Secretary Janet Yellen, the U.S. could default as early as October 18 if the debt ceiling is not raised by then. The ceiling legally limits the government's ability to borrow. The outcome of a dispute between congressional Democrats and Republicans over the limit could take many forms.

However, observers expect the outcome will be a a temporary suspension of the limit or an increase, as has been the case in the past. In the meantime, the uncertainty generated by this issue is significant and will likely be reflected in consumer confidence indices, which have been low recently.

Retail sales rebound, but autos are still a drag

Despite auto sales falling for a fourth consecutive month in August, retail sales regained some lost ground in July, rising 0.7% over June sales, a sign the Delta variant is doing less damage than once feared. However, this will likely not be enough to produce positive gains in overall consumption in the third quarter.

Car sales represent 20% of total retail sales. The main cause of depressed sales is delivery delays, amid continuing computer chip shortages that are crimping production.

U.S. labour shortages continue

While the U.S. economic recovery has been strong so far, surpassing its pre-pandemic level in the second quarter, the country is facing severe labour shortages. Almost 5 million jobs were still needed in September to reach pre-crisis levels.

The U.S. unemployment rate bottomed out at 3.5% before the pandemic began. It stood at 4.8% in September, an improvement of 0.4 points from August. However, businesses are struggling to find workers.

According to the U.S. Federal Reserve, this was the result of increased labour turnover, including massive early retirements, people juggling work and child care needs, difficulties in negotiating job offers and the effect of unemployment benefit supplements.

Those supplements have begun to end, which should in theory support improved employment gains. However, improvement has not been seen in states where the supplements have already ended.

The COVID-19 crisis may have effectively reduced the country's pool of potential workers, and it’s not clear they will re-enter the labour market once the pandemic is over.

The impact for your company

  • U.S. consumption has already begun to moderate as uncertainty undermines consumer confidence. This could slow Canadian exports further.
  • U.S. manufacturers can't find workers to meet their needs. If your investment projects rely on U.S. technology, or if a large portion of your customers are U.S. companies, or if they are part of your supply chains, expect delivery delays and plan accordingly.
  • Despite a pickup in economic activity, the unemployment rate remains far from its pre-pandemic level. The Federal Reserve should continue to be cautious in its approach to monetary policy. Discord over the government debt ceiling could create further fiscal instability.
Oil market update

An energy crisis is emerging in Asia and Europe

Oil prices rose as investors feared a supply shortfall due to rising demand in some parts of the world. However, crude demand slowed in response to a Delta variant surge in some net oil importers over the summer.

For example, measures by Chinese authorities to stem the latest COVID-19 outbreak curbed mobility by about a third in that country, reducing consumption by 890 thousand barrels per day.

The good news is the situation appears to be improving. India's oil imports reached a three-month high in August after hitting their lowest level in nearly a year in July. Crude refiners increasing their reserves as such is a good sign they are expecting a strong rebound.

Global oil demand will rebound in October as activity is expected to pick up in China and several other Asian countries. But the seasonal drop in travel in the developed countries could limit the gains. Demand is expected to reach pre-pandemic levels early next year as the world economy recovers.

The supply side is struggling to respond

On the supply side, Hurricane Ida caused the interruption of 90-95% of crude oil and gas production in the U.S. Gulf region because of damage to pipelines and other infrastructure. It was just another addition to a list of problems that have disrupted the recovery of U.S. supply since the pandemic.

Initially caught off guard by the rebound in demand, OPEC+ countries are straining to keep up with the growing need for crude. However, over the summer, they reached an agreement to release an additional 400,000 barrels each month over the previous month, which will add about 2 million barrels per day to the oil market by December.

What’s behind the price surge?

Brent crude exceeded US$80 per barrel and WTI reached US$78 in early October—a 10-year high.

The higher crude prices reflect a natural gas crisis in Europe and Asia. Oil consumption could increase by nearly 6% if natural gas prices remain high for an extended period. Even so, at the Orgranization of the Petroleum Exporting Countries' last meeting on October 4, cartel members decided not to increase supply further.

Countries around the world are relying more than ever on natural gas to heat homes and power industries, amid efforts to move away from coal and increase the use of cleaner energy sources.

But there is not enough gas to meet demand, especially at this time of year when countries in the Northern Hemisphere are bidding for supplies to cover winter needs.

Europe and Asia are particularly affected by natural gas scarcity. European inventories are low due to maintenance work and limited Russian export supply.

On the other side of the globe, Asia is a major source of natural gas demand, particularly to fuel Chinese manufacturing. While Chinese imports continue to grow at a healthy pace, it appears they may not be enough to meet the country's demand

A push by the Chinese government to move away from coal, which has also becoming scarce and expensive of late, coupled with the general economic recovery, is making international competition for energy fierce.

Bottom line

Oil prices are rising. These increases are driven by a stronger than expected recovery in demand and a supply that remains limited. The scarcity of natural gas in Asia and Europe could push countries to further increase demand for crude oil in the coming months.

Other economic indicators

Bank of Canada's job is getting harder

The recent slowdown in economic activity and the accumulation of challenges facing businesses do not suggest a strong likelihood of a change in monetary policy by the Bank of Canada on October 27. The issue is becoming more challenging for the central bank, however, as inflation expectations continue to accelerate and labour market conditions favour wage growth.

Opposing forces should maintain a stable loonie

The Canadian dollar fell from US$0.80 in early September to less than US$0.78 about 20 days later. This drop was mainly due to the uncertainty that was generated by the federal election. Since Election Day, the loonie has effectively resumed its upward trend and is starting the fourth quarter just above 79 cents. The most recent price increases in energy markets, including oil, could push the Canadian dollar higher, but the rising uncertainty in the U.S. is mitigating this risk so far. The balance of these effects suggests that the CAD will remain stable against the USD at around 0.80.

Pessimism is back among Canadian SME

Uncertainty in Canada rose following the start of the federal election campaign in mid-August. According to the Canadian Federation of Independent Business, this was the main reason for the sharp drop in the business barometer index in September. Confidence among Canadian business leaders dropped nearly 10 points in a single month. The index fell from 67.1 in August to 57.8 in September. This is the worst result for the index since last November when an effective vaccine for COVID-19 was still unannounced and the country was dealing with the second wave of the virus.

Inflationary pressures: the transition is getting longer

Cost pressures continue in this country. In addition to the so-called base effect, many economists agreed that the inflation of the past few months was transitory. That is because the price growth is the result of a temporary imbalance between limited supply that has been unable to meet the high demand generated by the pandemic and the various health measures imposed around the world to deal with it over the past 18 months. While these multiple imbalances should eventually resolve themselves, the timing of their correction seems to be getting worse each month. New pressures are also emerging as supply shortages spread across new sectors of the economy. In addition to pressure on material costs, pressure on wages is also increasing as companies once again face labour shortages. Inflation may therefore prove to be hold longer than initially anticipated.

Key indicators—Canada