Monthly Economic Letter

January 2022
Feature article

What to watch for in 2022?

Last year wasn’t easy for Canadian entrepreneurs. The restrictions imposed to deal with the pandemic have tested the resilience of business owners in extraordinary ways. As the economy continues to recover, what will shape the business environment in 2022?

1. The pandemic continues to create uncertainty

It’s likely the pandemic will once again dictate the path the economy takes this year. As we’re seeing with the Omicron variant, Canada remains vulnerable to new waves of COVID-19 infections despite the country’s enviable vaccination rate. Distancing, masks and limitations on the size of gatherings should remain in effect to counter the virus’s spread this year.

Several countries have reached new records of cases due to the latest variant, forcing authorities to tighten health restrictions. In Canada, the largest provinces reinstated drastic measures such as complete business closures. Although the isolation period has been cut in half for most Canadians, this other round of lockdowns could once again slow the economy early in the year.

2. Pressure on supply chains will continue

Many companies have encountered supply problems since the economy reopened and, unfortunately, we don’t foresee these challenges going away anytime soon.

The recovery has begun in earnest, creating high demand for goods. In order to respond to the tsunami of orders, factories have accelerated production, which has resulted in a high demand for transportation to move raw and intermediate materials. Meanwhile, finished goods continued to pile up in warehouses and ports due to a lack of containers and personnel to handle cargo.

The logistics problems have grown to the point where it will take months, if not years, to resolve them. Bottlenecks have affected industries throughout the production chain with significant multipliers and international spillover effects. Shortages will be most acute for hard-to-substitute products.

The emergence of the Omicron variant threatens to exacerbate the problems. China still maintains a zero-tolerance policy for outbreaks, which could close factories or ports. In Europe, the number of cases is increasing and several countries, notably Germany, could quickly reimpose severe lockdowns. Each disruption creates disproportionate spillover effects across different parts of the production chain.

3. The scourge of 2022 will be inflation

The consumer price index rose rapidly at the end of 2021. On the one hand, the base effect has inflated the inflation rate because prices, especially energy prices, fell drastically at the very beginning of the COVID-19 crisis.

Despite this effect, there are real price increases stemming mainly from an imbalance between supply and demand that is being exacerbated by supply chain bottlenecks.

We believe the current bout of inflation comes from transitory effects albeit will last longer than initially expected. Price growth will not reach the double-digit levels of the 1970s but will remain above 3% in 2022—especially in the first half of the year. Inflation should moderate as supply/demand imbalances are resolved and the Bank of Canada takes action later this year.

However, energy price increases, such as those experienced recently, could persist in the coming years against the backdrop of the energy transition. The transition comes with a realignment of investment towards clean technologies at the expense of their more polluting counterparts, which remain the main source of energy currently. This phenomenon will lead to episodes of volatility in the energy markets.

4. Interest rates will rise

In order to counter rising inflation, the Bank of Canada is expected to announce its first rate hike in the first half of 2022.

Since the October announcement of the end of quantitative easing, effective interest rates have already begun to rise quietly and will gain momentum as monetary policy is tightened. Overall, we will remain in a low interest rate environment for a long time to come, even if the trend is upward.

Central banks are trying to guide the economy to a sustainable pace where neither stimulus nor restraint is needed—in other words, to a neutral rate. The Canadian neutral rate estimated by the Bank of Canada has been falling for several years.

Rate increases are likely to be gradual and the Bank of Canada is expected to be cautious given the high level of debt in the economy. Households and governments are stretched and more vulnerable to rate hikes than in the past.

As a result, the first hikes should be effective in slowing demand. Monetary policy could therefore have the desired effect more quickly than we were used to before. On the other hand, the planned rate hikes could lead to a further boost in housing demand and investment in the early months of the new year as households and businesses take action ahead of the increases.

5. Labour problems will remain acute

Canada's labour force issues are not new, nor will they go away on their own. Employers have been dealing with an aging population for a number of years now, but the pandemic has accelerated the retirement of baby boomers and stunted the main source of Canadian population growth—immigration.

The new wave of COVID that took hold in late 2021 will likely not be the last because the distribution of vaccines continues to be uneven globally. Each new wave not only brings restrictions for businesses, but also slows the nation's immigration efforts.

The nation's job vacancy rate is still hovering around 1 million, despite the fact that the number of workers continues to grow and the participation rate has returned to pre-pandemic levels fairly quickly.

The lack of personnel is forcing many companies to reduce their service offerings and could also restrict business investment. This is a headache that will slow growth in 2022. One excellent way to counter a worker shortage is to invest more in labour-saving technology.

Key points to keep in mind for 2022:

  • Canada's economic recovery will be robust thanks to the good financial situation of households and the performance of capital markets, but the challenges are mounting.
  • The pandemic is not over. Supply chain disruptions and logistics challenges will persist through 2022 and possibly beyond.
  • The energy transition will lead to higher energy prices and episodes of market volatility.
  • Labour force issues will continue to constrain the supply of workers.
  • Inflation remains transitory in nature, although it will last longer than initially expected. Financing conditions will tighten in 2022, although they will remain affordable.
Canadian economy at a glance

Backtracking: Omicron slows the Canadian recovery

Increasing restrictions in Canada and elsewhere around the world to combat the Omicron variant will hamper the economic recovery as we enter the new year. However, we expect the Canadian economy to continue to show resilience.

The risk lies almost entirely with high-contact industries such as accommodation, food service and the arts and culture sector. Many Canadians have already cancelled trips and events even without being forced to do so. Each new wave increases an imbalance in recovery among sectors.

The fourth quarter will have brought some relief

Real GDP grew by 0.8% in October compared to 0.2% in September as pandemic health measures continued to be withdrawn across the country.

According to preliminary data from Statistics Canada, GDP growth came in at 0.3% in November, confirming strengthening growth in the last quarter of 2021.

Food services and accommodation were however less busy than they were this summer (-0.5% from September).

These sectors, which had been slower to rebound, experienced lower growth in October, reaching 87% and 82% of their pre-crisis activity levels, respectively. The fortunes of these industries are obviously expected to suffer another setback in coming months due to Omicron.

The manufacturing sector did well in October, despite ongoing supply problems. The sector grew by 1.8% compared to September, thanks to the reopening of automobile and parts plants (+19.1%), among other bright spots.

Job gains in December despite Omicron

Employment increased by 54,700 in December despite the addition of health restrictions in Ontario and Quebec. The economic recovery of recent months has more than made up for the historic job losses at the height of the COVID crisis. To date, there are still 240 500 more jobs than in February 2020.

However, these figures are from mid-December and therefore do not take into account all of the new restrictive measures. January data may therefore show the first decline in employment since May 2021. We expect those job losses to be concentrated in Quebec and Ontario, the first provinces to reinstate restrictions.

Inflation continues to rise

The Consumer Price Index rose 4.7% in Canada in November compared to 2020. While this pace is similar to October, it marks a 30-year high.

More importantly, one measure of core inflation, CPI-common, the Bank of Canada's preferred benchmark, rose to 2.0%. This suggests inflationary pressures are spreading further through the economy. The situation could force the bank to raise rates more quickly than previously forecast despite an economic slowdown brought on by Omicron.

After a recent review, the Bank of Canada's mandate was reconfirmed. New wording regarding full employment simply puts on paper what the bank’s executive committee had already been doing.

The impact for your business

  • The next few weeks will be difficult as restrictive measures remain in place. This step backwards will once again test the resilience of the industries most affected by the pandemic.
  • While the economic recovery may be slower in the first quarter of 2021, growth will quickly take hold again once this new wave is behind us.
  • Interest rates may begin to rise soon despite the weight of the new variant on the economy. Inflation continues to spread widely through the economy and Omicron may even exacerbate the factors behind these price increases.
U.S. economy at a glance

A tough winter for the U.S. economy

Omicron is spreading faster than any other COVID-19 variant, and the United States has not been spared. Despite a dramatic increase in cases, U.S. authorities have not yet reinstated measures to slow its spread. The country is relying more on third vaccine doses, available to all, than on restrictions. To date, about 30% of the American population has received a booster shot.

While no revision was made to third-quarter GDP growth (still estimated at 2.3% compared to the second quarter), the economy will likely take a hit from the surge in COVID cases, exacerbated by the holiday gatherings and the travel they bring.

The new variant has not shaken the Fed so far

The Federal Reserve’s Open Market Committee held its final meeting of 2021 on December 15 in the midst of the new COVID wave. The committee announced it will remove stimulus from the economy faster than previously expected by accelerating the reduction of its asset purchases. The end of the quantitative easing program was thus brought forward from June to February.

The end of the program opens the door to rate hikes next year. Inflation has been at a 40-year high for several months now, and the unemployment rate is close to its pre-pandemic low, which effectively means that monetary policy tightening is in order, sooner rather than later.

The Fed has so far been more concerned about inflation than Omicron. GDP growth is expected to slow this winter, but it is unclear how inflation and employment will react this time. Households and employers are becoming more accustomed to the waves of COVID-19 and their behavior is less and less influenced by them.

Nothing to improve consumer confidence

The pandemic is still weighing on consumer confidence. Although confidence indices were up slightly in December, levels remain well below where they were before the crisis.

U.S. consumer confidence rebounded in the spring of 2021, before the Delta variant took hold. Since then, high rates of inflation and a rising number of COVID-19 cases explain why optimism remains muted. Without the extraordinary support measures of a year ago, consumption is expected to slow this winter.

Employment is still too low

While the overall level of employment continues to improve in the U.S., gains have been disappointing since the fall. The U.S. economy barely added 200,000 jobs in December, a somewhat lower increase than in November.

The unemployment rate continued its downward trend to 3.9%, down 0.3 points from November. Despite the unemployment rate approaching the historic low seen before the pandemic, the U.S. is still more than 3 million workers short of the February 2020 peak.

U.S. employers continue to struggle with the massive resignation movement dubbed "The Great Resignation." Voluntary quits are at near-record levels and job vacancies have been growing in recent months. It’s a safe bet that the new wave of infections will mean that employers don’t get the relief they’ve been waiting for.

The impact for your business

  • The deteriorating situation related to the pandemic, coupled with the difficulties in the labour market, point to difficulties for the U.S. economy in the coming months.
  • These conditions pose a risk to U.S. consumption and, consequently, to Canadian exports for the winter.
  • Now that the Federal Reserve's first interest rate hike is expected before the Bank of Canada's, and with uncertainty returning to the markets due to Omicron, the Canadian dollar could depreciate further this winter.
Oil market update

A short breather for consumers

Crude oil prices fell quickly as concerns mounted over the new Omicron variant in December. North Sea Brent crude traded at US$70 a barrel, down 20% from its November peak. In New York, West Texas Intermediate fell to US$65.

For consumers, however, the price drop was likely to be welcome. Consumers have had to deal with particularly high inflation rates this fall, largely due to gasoline prices. The breather was, however, short-lived.

Prices have resumed their upward trend as quickly as they fell. The rally in crude prices is a reflection of supply being too low to support demand, despite the economic slowdown the new wave of infection is expected to cause.

Demand recovery pauses

Restrictions are again multiplying internationally, especially in Europe due to the spread of a new variant of COVID-19, which is suspected to be more contagious. In the Netherlands, a complete lockdown has returned in advance of the holiday season.

The end-of-year celebrations and the fear of the spread of the Omicron variant of the virus motivated these decisions, and this despite the high vaccination rates in most developed countries. As a result, telecommuting and travel restrictions are expected to continue this winter. Therefore, the recovery in oil demand will be on pause for a few more weeks.

Omicron thus proves OPEC right

The feud between the Organization of the Petroleum Exporting Countries and major crude consumers including the U.S. and China has finally been resolved by the new variant. As the cartel expects the impact of Omicron to be moderate or at least short-lived, OPEC and its allies will continue to resume crude production as planned in this summer's agreement.

Despite this, OPEC+ production remains below the agreed level. Member countries were reportedly 117% compliant with cuts in November and 116% compliant the previous month. Thus, even though production is increasing, it remains below its targets, which may explain some of the price increases we are seeing. This also means that even if the pause in demand turns out to be worse than OPEC expects, the still limited supply of crude would help keep prices higher than during previous COVID-19 waves.

Bottom line…

Crude oil prices will continue to adjust as uncertainty increases in the markets about the extent to which Omicron will affect economic activity around the world. On the one hand, recent price declines will provide some relief to the inflation rate in the coming months, to the delight of consumers and probably some central banks as well. However, it would be surprising to see prices fall again as the world gets more used to dealing with the pandemic each day and oil supply is still limited and adjusted to the situation.

Other economic indicators

No rate hike in January

While the surge in new daily cases in Canada and the introduction of restrictive measures to deal with them will slow the recovery early in the new year, the Bank of Canada is expected to announce its first rate increase by mid-year. The surging inflation of recent months continues to spread widely through the economy and the new Omicron variant may even worsen the factors causing these price increases. The Bank will likely maintain the status quo at its January 26 meeting as there is still a lot of uncertainty surrounding the impact of this new wave.

The loonie rebounds after a slight decline

The rebound in oil prices since late December continues to support the Canadian dollar around US$0.78 after the slight pullback brought on by the new wave of infection in the country. The Federal Reserve's more aggressive tone on tightening monetary policy and the economic uncertainty resulting from the new lockdown measures implemented in Canada are the main reasons why the loonie has not appreciated further. The loonie should remain below US$0.80 in the short term.

SME long-term confidence remains stable

The Canadian Federation of Independent Business' Business Barometer Long-Term Index held near its November level in December, reaching 62.6. The long-term index captures the expectations of business leaders over a 12-month horizon, while the short-term index captures expectations over a three-month horizon. Obviously, the importance of the new wave of COVID-19 infection caused by Omicron was reflected in the short-term confidence index, which dropped nearly five points last month. The index was still below 50, which means that more companies are expecting weaker performance in the first quarter of 2022.

Key indicators—Canada