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Monthly Economic Letter

February 2022
Feature article

After an inflationary surge, will commodity prices stabilize in 2022?

The recession caused by the pandemic and the recovery that’s still underway have brought new economic concerns to the forefront for many entrepreneurs. Among these is a sharp rise in commodity prices.

While these increases are generally good for Canada’s export performance and therefore its economic growth, they are a major issue for many entrepreneurs. Will these price increases continue in 2022?

Surging prices seen for many commodities

Energy prices are rising towards the peak they hit in 2014 before a price collapse dealt a heavy blow to the Canadian oil and gas sector and the economy as a whole. Elsewhere, lumber prices have been on a rollercoaster ride; metal prices continue to move higher; and consumers are struggling with increasing grocery bills.

Unsurprisingly, the main reason for the commodity price spikes is a supply/demand imbalance caused by the pandemic. As these imbalances begin to resolve, commodity price volatility should ease slightly this year. However, we don’t expect a full return to normalcy to occur until 2023.

1. Energy

With the global economic recovery comes strong demand for energy. Once high energy demand related to the cold season passes and production increases, prices for many energy products are expected to decline to more stable levels, although higher than those experienced before the pandemic.

Since mid-2020, oil consumption has outpaced production. The reopening of economies has boosted energy demand, leading to a crisis in Europe and Asia. To counter a shortage of natural gas, many countries have turned to oil and coal to meet their needs.

Oil and gas production is expected to continue to increase throughout the year but will only be sufficient to replenish inventories by the end of 2022. Energy prices should therefore remain high, or even increase, in the short term. However, they should begin a downward trend later this year.

2. Metals

The majority of non-precious metals enjoyed an exceptional year of price increases in 2021. Record demand for goods, including such metal-intensive products as cars, appliances and electronic equipment provided support for metal markets. On the supply side, inventories built up in recent years were rapidly depleted.

This year, consumers are expected to move a portion of their spending on goods to services as lockdowns are eased. A slowdown of the Chinese economy, the most important player in the metals market, should also calm the recent demand frenzy.

On the other hand, supply will continue to be limited by high energy prices. Metal production is highly energy intensive and, at current prices, some plants and foundries have no choice but to close. This is the case for aluminum in China and zinc in Europe. As a result, many metal prices will remain near or slightly above recent levels, but relief is expected to come in early 2023.

3. Lumber

The lumber market was hit by extreme price swings in 2021. Here, prices appear to be heavily influenced by the evolution of the pandemic. In early May 2021, the price of hardwood planks of various lengths was more than six times higher than in April 2020. Prices eased briefly during the summer season before rebounding in early fall as the Delta variant took hold in the U.S. and flooding in British Columbia made freight transportation difficult.

The rise of telecommuting and recurring lockdowns has created new real estate needs. Housing starts and renovations reached record highs during the pandemic on both sides of the Canada-U.S. border. Much of the momentum in the residential sector has come from increased household disposable income and low interest rates supported by fiscal and monetary policies. Demand will remain strong in 2022 but will slow from last year's peak.

The era of cheap money is coming to an end with central banks removing stimulus and should be reflected in the housing—and therefore lumber—market in the coming months. It should also be noted that import tariffs on Canadian lumber doubled for Americans, from 9% to 18% in November.

Supply will remain tight in the coming years due to insect infestations and the increase in forest fires that deplete the resource a little more each year. The lumber market could once again see significant price swings, but prices should stabilize later this year once endemic levels are reached in Canada and the U.S. and rates have recovered from their lows.

4. Agri-food products

While food inflation affects consumers more than businesses, food price increases still impact a wide variety of companies. This is because consumers adjust their spending on other items based on their grocery bill. According to many experts, food inflation will continue into 2022.

In addition to supply chain issues, the industry is being hit by labour shortages, production slowdowns caused by pandemic health measures and high energy costs. Additionally, food producing regions have been plagued by difficult weather conditions, including a drought on the Canadian prairies last summer.

While wages are expected to rise in 2022, this will not be enough to fully offset the impact of food inflation on consumers’ pocketbooks.

The impact on your business

  • Energy prices should only correct in the second half of the year. If your business is energy intensive, try to see how you can improve your operational efficiency to reduce your energy needs. Although prices should fall later this year, reducing your energy dependence will be good for you in the longer term.
  • Households will have to revise their budgets to cope with interest rate increases and food inflation. This may hurt demand for certain goods or services.
  • Consumption of goods and residential spending should moderate this year but remain high. This will be reflected in lumber and metals markets, which will remain strong but nowhere near the growth rates seen in 2021.
Canadian economy at a glance

Canadian economy surpassed its pre-pandemic level in November

Good news: growth continued to strengthen in the final quarter of 2021. Monthly GDP finally reached its pre-pandemic peak in November. However, that was before the Omicron wave hit Canada, forcing the reintroduction of health measures across the country.

Gross domestic product continues to rise

Real gross domestic product rose 0.6% in November on top of October's solid gain of 0.8%. The growth was broad-based across both goods and services industries. Only three of the 20 industries surveyed by Statistics Canada slowed during the period. This was well above analyst expectations, especially considering the impact of flooding in British Columbia on freight transportation during the month.

Of particular note was a rebound in the accommodation and food services sectors in November. After two months of decline, restaurant and bar activity finally benefitted from the lifting of capacity limits (+2.0% compared with October). There was also a strong improvement in accommodation services (+7.1%), thanks to the return of travellers.

There is still a long way to go before these sectors, which were hardest hit by the pandemic, are back on their feet. Omicron will likely further accentuate imbalances between sectors that has marked the pandemic recession.

Decline in employment: Blame it on Omicron

As expected, the labour market is starting 2022 on a sour note. Employment fell in January, the first national decline in eight months. Once again, job losses were concentrated in the sectors most affected by the pandemic, including accommodation and food services (-113,000), and the arts and culture industry (-48,400).

The losses were concentrated in Ontario (-145,700) and Quebec (-63,000), the provinces that have been the most aggressive in locking down to combat Omicron. The picture should brighten as soon as February with the removal of certain health measures.

Interest rate: Mark your calendar

The stage is set for the Bank of Canada to raise its policy rate for the first time at its meeting on March 2. Inflation hit a 30-year high in December at 4.8%. There was still too much uncertainty about the size and duration of Omicron's impact on the Canadian economic recovery to raise rates at the January meeting. Data capturing the impact of the latest round of lockdowns will still be scarce by the time the bank has to make its decision in March, but according to the provincial plans the economy should be almost fully reopened by then.

Before Omicron, the economy had good momentum. Business confidence, investment intentions and hiring intentions were all in the green. Once the latest restrictions are lifted, confidence should rebound strongly and continue to boost Canadian business productivity.

The impact on your business

  • The economy was building strong momentum this fall before latest round of health restrictions slowed the recovery. It should resume in the spring.
  • Despite a significant downturn in employment related to Omicron, labour needs remain acute. In fact, these latest layoffs will prove to be more temporary than in previous waves.
  • Prepare your business for interest rate increases. Whether you have planned investment projects or not, you will feel the impact in the coming months, as rate hikes combine with inflation to reduce household purchasing power.
U.S. economy at a glance

U.S. posts an exceptional year of growth in 2021

The U.S. economy grew at a remarkable 6.9% pace in the fourth quarter of 2021, according to early estimates. This brings overall GDP growth to 5.7% for the year, a record not seen in almost 40 years.

This outstanding performance more than made up for the 3.4% contraction the economy suffered in 2020. While it is difficult, if not impossible, for the U.S. to continue at this pace, the growth outlook remains strong.

High consumption pushes companies to increase inventories

The main driver of growth in the fourth quarter came from businesses replenishing inventories to meet strong demand for goods.

Pandemic lockdowns dampened spending on services in favour of spending on goods. Consumption was also boosted in 2021 by extraordinary government stimulus and very low interest rates. Increased inventory investment is responsible for more than 70% of the total growth in the fourth quarter.

Between the last two waves of the virus that hit the U.S.—Delta in late summer and Omicron in late December—consumption had time to recover strongly. However, a slowdown is likely to have occurred at the beginning of this year, mainly due to the impact of Omicron. Retail sales had already started to decline in December (-1.9% vs. November).

Omicron's effect on the U.S. economy is expected to ease in February with a sharp decline in the number of cases.

Residential investment down

Construction and renovation spending continued to fall in the fourth quarter. The 0.8% decline follows a 7.7% contraction from July to September. While housing demand is still high, supply chain problems and price increases are having a cooling effect.

With Federal Reserve rate hikes on the horizon, it will likely become increasingly difficult to reach the record levels of a year ago.

Omicron had no major effect on the U.S. labour market

Despite Omicron, the U.S. labour market posted employment gains for the 13th straight month. The unemployment rate increased marginally at 4.0% in January, despite the addition of 467,000 jobs nationwide.

The number of Americans receiving unemployment benefits increased during the month, and the impact of Omicron was reflected in higher absenteeism and lower hours worked. The picture should quickly improve now that the recommended isolation period has been revised downward and the number of COVID-19 positive cases is decreasing.

Despite large waves of COVID-19 in the U.S. in 2021, the economic recovery will still have created an unprecedented 6.4 million jobs in the space of a year.

To curb inflation, the Fed will raise rates

The Federal Reserve has signalled that its first rate hike could come as early as March, with several more to follow. The Fed has no choice but to tighten monetary policy, even though the country's employment level is still not where it was before the crisis. After years of low inflation, the consumer price index jumped 7.0% between December 2020 and December 2021, another 40-year high.

A key reason for the staggering inflation increases is supply problems caused by the pandemic. Surging prices for vehicles (new and used) and oil are responsible for 46% of the growth. Rising interest rates should slow demand, but prices will remain high as long as supply problems persist.

The impact for your company

  • The economic recovery in the United States was very strong in 2021. Growth is expected to continue to be robust, but the expansion won’t continue at the same pace. U.S. demand for Canadian goods and services will be more modest.
  • U.S. inflation is surging. The Federal Reserve will be raising rates this year to counter rising prices. If your sales rely on a large base of U.S. consumers, expect some decline in demand.
Oil market update

Oil prices are skyrocketing

Oil prices have been on a meteoric rise this year. North Sea Brent and WTI futures were both trading near US$90 per barrel at the end of January. This represents increases of 13% and 17%, respectively, in 2022. Prices are inching closer to the highs reached in 2014. That surge plunged Canada into a technical recession.

The cost of geopolitical tensions

One of the reasons for the recent price momentum is the growing threat of war between Russia and Ukraine. Western countries, including Canada, the United States and their European allies, have warned that heavy sanctions would be imposed in the event of a Russian invasion. Russia's potential response would not be insignificant.

In the current context of natural gas scarcity in Europe and high oil prices, a major disruption in the supply of Russian energy to Europe could have devastating consequences. Russia supplies about 40% of the European continent's natural gas and more than half of its coal. It is also a major supplier of crude oil. The risk of serious disruption to energy markets is a major contributor to current high prices. This premium is therefore transitory in nature, but the duration of its effect is highly uncertain.

Fundamental factors remain the main driver of price increases

Apart from the risk premium associated with these geopolitical tensions, supply and demand remain the main drivers of the recent price surge.

Inventories are running low and the spare production capacity in the Organization of Petroleum Exporting Countries (OPEC) is shrinking. This is the result of weak investment in recent years due to the pandemic and low prices.

Crude supply is also limited by lower production from countries outside OPEC. The United States, the world's largest oil producer, is not pumping as much as it could. Oil companies in the west are facing pressure from investors to accelerate the decarbonization of their operations rather than increase production.

On the demand side, economic concerns related to the Omicron variant are fading fast as the latest wave of infection continues to dissipate globally. As a result, oil demand is expected to continue to accelerate. At its recent pace, global oil demand could not only return to the pre-pandemic levels soon but even exceed them by year end.

Bottom line…

Barring another round of pandemic lockdowns, there is little prospect of a significant decrease in crude prices in the short term. Demand for oil is growing; inventories are low; spare capacity is dwindling; and the energy transition is holding back investments needed to increase production in western countries.

There is also the risk that recent geopolitical tensions could escalate. The resulting cycle of sanctions and retaliation could have severe consequences while the world is still recovering from the pandemic and energy shortages. Even if a major price correction were to occur, similar to 2015, the impact of lower prices on Canada would be less damaging because the sector's investments are much lower today than they were then.

Other economic indicators

First interest rate hike expected in March

The next Bank of Canada meeting will be held on March 2, 2022. The overnight interest rate in Canada will most likely be raised to 0.50%. The Bank will have little data on the actual impact Omicron will have had on the economic recovery, but the strong performance in the fourth quarter should be enough to justify a first rate hike. In the last announcement, the Governor also hinted that the Bank will reduce the size of its balance sheet this year. As a result, liquidity is expected to become more limited in the country.

The loonie remained stable in January

The Canadian dollar ended January exactly where it started, at US$0.79. The Canadian currency received some support from the surge in oil prices and the strong performance of the economy in November without, however, appreciating against the greenback. Canada experienced significant job losses in January while Omicron does not appear to have shaken the U.S. labour market—which will be supportive of the U.S. dollar. Therefore, the loonie is expected to remain slightly below US$0.80 again in February unless there is a major revision in oil prices.

Omicron slashes business confidence

The Canadian Federation of Independent Business (CFIB) Business Barometer's long-term index decreased to 54.3 in January. This is the lowest level recorded in 16 months. The long-term index captures the expectations of small business leaders over a 12-month horizon. Obviously, the extent of the new wave of COVID-19 infection caused by Omicron and the sanitary measures imposed to deal with it explain this decline. The index was still above the 50 mark, which means that more companies are expecting a better performance in 2022 than in 2021. With the health restrictions fading away in February, optimism should bounce back in the coming months.

Significant salary increases in 2022

According to CFIB, the number of companies expecting to raise wages in 2022 has increased significantly from previous years. These increases would also be much more substantial. Half of SMEs expect to increase wages by at least 3 percent in 2022, according to December estimates. Large wage increases are to be expected considering the current Canadian environment marked by labour shortages and high inflation, but it remains to be seen whether business expectations will materialize.

Key indicators—Canada