Monthly Economic Letter
Will wages continue to rise?
With fierce competition for workers in this country and unemployment at an all-time low, it's no surprise wages are rising fast. In addition to putting pressure on business costs, this trend could help provoke an inflationary spiral. Let's look at wages and the factors that will influence them in the coming months.
Where we stand
At the start of the pandemic, the average wage in Canada jumped by 10% in April and May 2020, on a year-over-year basis. This wasn’t due to wage increases, but rather the elimination of low-paying service jobs. Canada lost nearly 3 million jobs in the initial months of the pandemic.
More than two years have passed since then and the labour market has recovered. Having surpassed its pre-pandemic peak a few months ago, unemployment rate hit an historic low of 4.9%.
However, employment is still below its pre-pandemic trend line, meaning the level the country should have reached if job creation had increased at its long-term rate without COVID. Unlike employment, wages appear to be continuing on a new trend well above pre-pandemic levels.
The scale that wage increases have taken in 2022 is significant. Hourly wages have increased on average by 4.0% year-to-date, compared to the historical pre-pandemic average of 2.7% growth. Moreover, in August 2022, wage growth was 5.4% year-over-year. This is the largest annual change in the last 20 years outside of the pandemic period.
These wage increases are in part a result of current labour market conditions. The unemployment rate has just risen to 5.4%, but remains historically low, and the number of job vacancies is unprecedented (over one million). On the other hand, the pace of wage growth is closely linked to inflation, which also reached historically high levels in recent months.
Competition for labour leads to higher wages
Many entrepreneurs will be able to easily guess one of the reasons behind these soaring increases: a lack of available labour. Businesses were dealing with a tight labour market even before the pandemic, but COVID exacerbated the problem.
The latest available job vacancy figures showed no sign of an easing in demand for workers as more than 1 million jobs were available in June.
To counter the shortage of staff, many companies are turning to wage increases. Of those that expect to face staffing shortages, 46% say they have increased their salary offers to new hires and more than 64% have boosted wages for current employees according to Statistics Canada.
Not surprisingly, salaries are rising faster in provinces and industries where labour shortages are more severe. This is particularly true in New Brunswick, Quebec and British Columbia, as well as the manufacturing and construction sectors.
Inflation adds to the pressure
Labour shortages aren’t the only factor behind recent wage increases. With both consumer prices and interest rates rising, workers have less and less money in their pockets. To keep pace, they’re demanding more pay. As a result, even companies that aren’t facing a labour shortage are having to increase wages for new and existing employees.
In recent months, inflation has risen at the fastest pace in decades due to non-wage factors. Now, salaries have begun to follow suit, reflecting growing expectations among workers that inflation will persist.
Indeed, inflation expectations have risen for both short- and long-term horizons, a development that’s of concern to the Bank of Canada as it struggles to bring down the inflation.
The significant growth of labour costs will hit company profits at a time when they’re already under pressure from rising input costs in general.
We’re still far away from an inflation spiral
While inflationary pressures are certainly increasing, we’re not seeing conditions for an uncontrolled spiral. We expect price increases to slow in the coming months, which should temper inflation expectations and ease pressure for higher wages.
We also expect the economy to slow. While a soft landing for the Canadian economy remains our base case, fears of a recession are growing. A slowdown should result in lower demand in the economy, providing relief for businesses grappling with tight labour markets and wage pressures.
However, any respite from demands for higher wages could prove short-lived. Canada's labour shortages are structural, due to the country’s aging population. They will persist for several more years, despite the country's ambitious immigration targets.
The impact on your business at a glance
- Wages are expected to continue to increase at a higher rate than they did prior to the pandemic, but the magnitude of recent increases will not become the new norm in the business world.
- Beginning in 2023, a cooler economy should provide some relief from the wage pressures you've been experiencing. However, you should stay on your toes because inflation expectations are high. It’s a good time to look for ways to improve your cost control.
- Investments in technology and training can help boost your company’s productivity and compensate for labour shortages.
Already feeling an economic slowdown
The Canadian economy had a solid first half of 2022. At the end of the second quarter, economic activity grew at an annualized rate of 3.3%.
However, challenges continue to mount for the economy as interest-rate hikes come from the Bank of Canada at a rapid pace. Indeed, the economy appears to be slowing faster than expected. GDP is reported to have contracted by 0.1% between June and July based on preliminary estimates from Statistics Canada.
Housing slowdown deepens
The residential sector was a major contributor to Canada's economic recovery after the early stages of the pandemic. The construction and real-estate services industries, which account for about 20% of the Canadian economy, were among the first sectors to return to pre-pandemic levels.
Now, a slowdown in the home resale market is weighing on the most recent GDP data. Residential investment fell by 27.6% between the first and second quarters, cutting more than three percentage points from growth in that quarter.
Despite this decline, residential investment remains high by historic standards and is still well above the levels seen before the market exuberance brought on by the pandemic. Thus, despite the size of the correction that’s hit the industry, it’s more a return to the historical trend than a collapse at this point.
The slowdown in the sector is attributable to the recent sharp increase in interest rates. The Bank of Canada has raised its key interest rate by 300 basis points since the beginning of the year, from 0.25% to 3.25% today. The sectors that are most sensitive to rate hikes—housing, construction and durable goods—should continue to feel the impact of rate hikes.
One exception so far is housing starts. They appear to be still on track, reflecting an acute need for housing in many markets.
Consumption is rebalancing
Canadian households have increased their spending (+6.9% annualized growth over the second quarter). Faced with rising interest rates and soaring inflation, Canadian households are faced with declining purchasing power and this is causing them to rethink their budget allocations.
Spending on services and semi-durable and non-durable goods has been more than sufficient to counteract a significant decline in consumption of durable goods.
The easing of COVID-related restrictions in February and March gave a boost to customer-facing industries in the spring. The accommodation sector, restaurants, the arts and entertainment industry as well as transportation were the main contributors to GDP growth in the last quarter.
The return of workers to the office has contributed to renewed spending not only on restaurant meals and other services, but also on semi-durable goods such as clothing and shoes. With the end of summer bringing an increase in office attendance, these sectors should continue to enjoy good demand.
Job gains are increasingly difficult
The labour market is usually a lagging economic indicator, meaning that it reacts some time after the economy changes. Thus, an economic downturn is usually accompanied by an increase in the unemployment rate, but with a lag of a few months.
For the time being, the Canadian economy continues to thrive, but job gains are becoming increasingly scarce. The unemployment rate increased to 5.4% in August, and employment declined for a third consecutive month.
The economy lost a cumulative 113,500 jobs over the past three months. This is a rather marginal loss for now in the context of a very tight labour market and persistently high job vacancies.
The imbalance between the supply and demand of workers accounts for much of the slowdown in employment at this point in the economic cycle. A more pronounced slowdown in economic activity in the country could translate into a higher unemployment rate over the medium term.
Where does the Bank of Canada stand?
Could a slowing economy lead the Bank of Canada to slow down interest rate hikes this fall?
Although real GDP growth in the second quarter was strong, it was still below the bank’s forecast. What’s more, a slowdown in July and anemic employment growth in the last few months are fuelling recession fears in Canada.
Other factors weighing in favour of a slower pace of rate tightening is an improvement in supply chains and lower gasoline prices.
However, as long as inflation doesn’t show clear signs of stabilization, we believe that the central bank will continue to raise its policy rate at least once more by the end of the year before taking a short break to assess the impact of the tightening as early as spring 2023. We do not expect the policy rate to exceed 4% before that.
The impact on your business
- Despite growing economic uncertainty, the Canadian economy remains well-positioned for continued growth. However, businesses should expect and prepare for a slowdown.
- Demand remains robust, but consumer sentiment has begun to return to normal. Whether it’s the housing market or durable goods—a return to pre-pandemic trend levels has begun. The consumption of other goods and services continues to recover, but this is also expected to moderate after a summer rebound.
- Companies looking for workers don’t seem to be benefitting too much from the few job losses that occurred in the country during the summer. The unemployment rate remains low and workers are in high demand. In the current economic climate, make sure you have a good retention plan in place to reduce employee turnover.
It is not all doom and gloom
The U.S. economic situation is increasingly worrying businesses and consumers. After the first quarter ended with negative growth of 1.6%, estimates for the second quarter point to another decline of -0.6%. Despite the signs of slowing GDP, all is not doom and gloom for the U.S. economy.
Consumers hold the key
Rising prices and financing costs have limited the purchasing power of many Americans since the beginning of the year. Real consumer spending essentially held steady through the spring when U.S. inflation likely peaked. Lower energy prices appear to have helped produce a slight improvement in spending in July.
However, the end of fiscal stimulus and employment insurance supplements since 2021 have tempered the increase in household disposable income, despite strong employment growth. This is limiting the potential for stronger consumption.
Moreover, the strength of the labour market and the easing of price pressures in July were not enough to counteract Americans' pessimism about the economy. The consumer confidence index remains at a level that has historically only been seen during a recession.
In such an environment, consumption could rebound thanks to some price cuts in the months ahead and bring GDP back into positive territory, but significant gains look unlikely.
Production takes off again
Industrial production rose by 0.6% in July, a gain of 3.9% compared to the same period last year. This increase was driven primarily by a significant rebound in auto production to a new record high.
That was one of a number of signs that supply constraints are easing. However, supply chain disruptions still appear to be hurting production more than a slowdown in demand caused by rising interest rates.
Employment is still expanding
August marked the twentieth consecutive month of job gains in the United States.
Obviously, after a jump of more than half a million jobs created in July alone, the 315,000 created in August marks a slowdown in gains and the unemployment rate rose.
However, the rate remained at a very low 3.7%. And August’s 0.2 percentage point increase was actually good news because it reflected nearly 800,000 Americans entering the labour market.
The growing labour pool could ease pressure on companies facing worker shortages and help cool inflation. In July, the U.S. reported two job openings per unemployed person with more than 11 million job openings.
So... the economy is in recession?
Not so fast. The risk of a U.S. recession is real and, as Canada's largest trading partner, could push this country into recession as well. Since 1970, every Canadian recession has occurred at the same time as an American recession.
However, the most recent U.S. economic indicators are still in expansionary territory led by the strong labour market and expectations of a mild rebound in consumption. The easing of production constraints in recent months should also support economic activity.
The impact for your business
- U.S. consumption is expected to pick up in the second half of the year as households regain some of their purchasing power thanks to slowing inflation. This coupled with a weak Canadian dollar should bode well for Canadian exports.
- The easing of supply chain pressures is reflected in prices but also in industrial production. Increased industrial supply, particularly of vehicles, should help central bankers' efforts to control inflation on both sides of the border.
Back to pre-war prices, but for how long?
In August, the main oil benchmarks, Brent and WTI, traded at an average of US$98 and US$91 per barrel, respectively. Crude prices have been declining since July and the trend continued into early September when oil was trading below where it was before the outbreak of war in Ukraine.
Prices drop in response to recession fears
It's not just North America that coping with growing recession fears. Economic uncertainty from rising interest rates is being felt around the globe and affecting global energy demand.
New closures in China following the most recent COVID-19 outbreaks are adding to expectations of continued inflation and a slowdown in demand.
Economic uncertainty causes OPEC and its allies to flinch
Faced with the risk of a deep recession and an accompanying slowdown in energy demand, the Organization of the Petroleum Exporting Countries and its allies announced a reduced production target for October. It means 100,000 barrels of crude per day will not come to market compared to September levels, representing 0.1% of global demand.
This reduction, while minimal for now, is not good news for consumers or policymakers trying to contain inflation. While prices have been falling, the OPEC+ production cut suggests the coalition is targeting at least US$90 a barrel.
Thus, a more pronounced global economic slowdown than currently expected could translate into more OPEC+ moves to constrain supply in the coming months in an attempt to keep prices high.
G7 continues to retaliate against Russia
A new economic sanction against Russia looks to be coming and this one concerns its main financial resource in its war against Ukraine—oil. The finance ministers of the G7 countries have unanimously agreed on the imposition of a price cap on purchases of Russian oil.
Russian authorities were quick to warn the West that such an action would cause disruptions in their own oil market. They also said Russia is prepared to respond by redirecting its oil to Asia.
Even though Russian oil imports are already embargoed in North America, European countries are just beginning to break free of Russia's energy grip. In fact, the European sanctions on Russian oil only affect oil traded by sea for the time being and full unloading is not expected before the end of the year.
As recession fears gain momentum globally, oil and gas prices have begun to decline. Although still high, crude prices have returned to pre-war levels.
The anticipated slowdown in demand will not be enough to cause prices to fall much further to the dismay of consumers and central bankers who are hoping for lower inflation.
OPEC and its allies have announced plans to further limit crude supply, a sign the group would rather keep prices high than agree to Western demands to stabilize prices to support their economies. New sanctions against Russian oil could also increase the impact of OPEC's decisions in the future.
Another rate increase, and not the last one
The Bank of Canada is determined to bring inflation back to its 2% target. That is why it raised its key rate by another 75 basis points on September 6, bringing it to 3.25%, even as signs of an economic slowdown increase. The central bank is focusing much more on stabilizing the general price level than on GDP growth. Inflation appears to have peaked in June at 8.1%, as it was 7.6% in July and gasoline prices have continued to fall since then. However, pressure is building more broadly based on core inflation measures, which leads us to expect another rate hike as early as October.
Canadian dollar still falling
The loonie continues to lose ground as many commodities, including oil, correct. Fears of a global recession are gaining momentum, which also favours the U.S. dollar against the Canadian currency. The Canadian dollar is at 76 cents U.S. in September so far. Crude oil prices may slow down a bit more and economic uncertainty is accelerating. Both of these factors are expected to further weigh on the loonie. It would not be surprising to see the Canadian dollar hover around US$0.75 for the rest of the year.
Business confidence stagnates in August
Although economic growth continues, businesses have become more pessimistic this summer. In August, the Canadian Federation of Independent Business (CFIB) Business Barometer's long-term index remained at a low level. This indicates that more and more businesses are concerned about the direction of the economy over the next 12 months. However, an index above 50 still implies that there is more business leaders optimistic about the future than the opposite.
Financing costs on the rise
The policy rate being the boss of other interest rates in the country, the pace of monetary policy tightening by the Bank of Canada is translating into higher effective rates for households and businesses. Prior to the last policy rate hike in September, the Bank of Canada had raised the benchmark rate by 2.25 percentage points from March. The effective interest rate for households had increased by only 1.84 points and for businesses by 2.22 points over the same time frame. What explains this difference? Well, businesses are typically more likely to finance at variable or short-term rates, while many rates charged to households are fixed for longer periods. Nonetheless, both will continue to feel the pressure of ongoing rate increases.