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Monthly Economic Letter

February 2020
Feature article

Will wage gains continue?

After years of lacklustre wage growth, the pay cheques of Canadian workers are finally starting to reflect strong employment markets in many parts of the country. The question now is whether the wage growth will continue.

The labour market remains strong (with some exceptions in western Canada) with the unemployment rate hovering at 40-year historic lows. Canada’s economy created almost 25,000 jobs a month on average in 2019.

However, economic growth has been more subdued in recent months. In fact, the Bank of Canada lowered its GDP growth forecast for the fourth quarter of 2019 to just 0.3%. Monthly employment decreased in two out of three months of the quarter.

Nevertheless, labour shortages did not ease during the period. There are still over half a million vacant positions in the country. Indeed, 31% of businesses were still struggling with labour shortages in the last quarter of 2019, according to the Bank of Canada’s Business Outlook Survey. Similarly, a survey by the Canadian Federation of Independent Business found that around 25% of firms were struggling to find unskilled and semi-skilled workers and 43% were finding it hard to find skilled labour.

The strong labour market is finally reflected in wages

While the labour market has been tightening for years, wage gains have not kept pace. Canada’s unemployment rate reached an all-time low in 2019 at 5.7%, which is near full employment. We would normally expect wages to grow by about 3% a year under those conditions—2% to account for inflation and the remaining percentage point for productivity growth. This was not the case in 2018 or 2017. Wages grew at an average rate of 2.7% in 2018 (despite an unemployment rate of 5.8%) and by 1.6% in 2017 (despite 417K new jobs having been created that year).

The good news is that salaries have been increasing well above that 3% threshold for the past seven months. After a decade of moderate growth, wages have finally started to take off.

Not all Canadian workers are benefitting from bigger pay cheques though. Just like GDP growth, wage growth has varied significantly across provinces. BC, Quebec and Ontario, the provinces with the strongest demand for labour have experienced the highest wage growth.

But... Don’t expect the recent pace to continue...

Wage growth is expected to moderate in 2020. According to the average of multiple surveys on Canadian employers' salary plans for 2020, wages are expected to increase by 2.7% this year, slightly less than the levels seen at the end of 2019. Only 36% of organizations surveyed by the Conference Board of Canada plan salary increases for 2020 above the 3% threshold. Slower job creation in 2020 is why wage growth is unlikely to match 2019 levels.

Further, low productivity growth may cap future wage gains. Without productivity gains, companies aren’t in a position to increase wages above inflation. Robust wage gains like the ones we’ve seen in some provinces in 2019 aren’t sustainable in the context of low productivity growth.

Other than investments in technology, education and training, businesses can boost their productivity by better matching worker skills to job requirements. While it’s increasingly difficult for firms to find the right talent for jobs, a solid labour market should support higher job turnover rates. Higher turnover rates improve skill matching and enhance productivity, which, in turn, supports wage growth.

Even though the workforce is aging and older workers tend to favour stability over wage gains, the rate of people changing jobs in Canada has been rising in the past two years in line with the decline in unemployment rates and the high number of job vacancies.

All in all, wages should increase modestly this year. Wage growth will be more important in sectors where workers are in high demand, such as digital technology, skilled trades and professional services. However, the strength and duration of wage pressure will depend on whether business investment and skills training generate higher labour productivity and greater economic growth.

What does it mean for entrepreneurs?

  1. Be ready to raise wages and offer more benefits to employees, especially if you’re operating in a sector where talent is in demand.
  2. Seek help to optimize your input costs to offset rising labour expenses.
  3. Invest in technology and training to enhance your company’s productivity and ensure you remain competitive.
Canadian economy at a glance

Waiting for a bounce back

The Canadian economy softened recently with October and November 2019 coming in below initial expectations. The Bank of Canada's 0.3% growth forecast for the fourth quarter should hold—if December’s reading doesn’t offer any bad surprises.

What restrained growth in Q4?

Temporary events had a negative impact on economic activity during the fall. These one-off factors, combined with continuing trade tensions and a global economic slowdown, weighed on growth.

Difficulties in the automotive sector—Plant closures and production restructuring are not new to Canada’s auto sector. However, a strike by 48,000 auto workers at some 50 plants in the United States certainly hit hard. The strike lasted almost a month and a half in September and October. The sector is important to Canada, with motor vehicles and parts accounting for 8% of Canada’s manufacturing industry. The slump in the auto sector contributed to a decline in manufacturing output by 1.2% in October. Manufacturing output growth was flat in November.

Keystone pipeline outage—TC Energy stopped transporting oil on the Keystone pipeline for ten days in early November following a spill of approximately 1.4 million litres of oil in North Dakota. Although oil transportation resumed on November 11, the shutdown significantly reduced crude exports.

The resulting build-up led to a peak in Canadian oil inventories in the late fall. This accumulation and restrictions on oil production continue to put downward pressure on the Western Canadian Select benchmark price, which is hurting the western Canadian oil-producing provinces.

CN labour dispute—A strike at CN Rail lasted eight days in November before being resolved. As a result, the transportation sector was down 0.9% in November. The transportation restrictions also hurt other sectors such as agriculture and natural resources (-0.3%) and wholesale trade (-0.4%). Transportation issues also partly explain poor performance in the mining industry, which contracted by 4.0% (although sluggish Chinese demand for iron ore and potash also contributed to the sector’s bad month).

In light of the coronavirus’ impact on the Chinese economy, poor performance in the air transport sector and in demand for commodities are also to be expected, although it’s too early to estimate the specific impact of the virus on the Canadian economy.

What will drive growth in 2020?

Employment declined in October and November but fortunately has since recovered. After an increase of 27,000 in December, 35,000 new jobs were created in January. Job creation is expected to continue throughout the year, although at a more modest pace.

Not only are more Canadians working, but wages began to rise in mid-2019. Wage growth is expected to continue through the year, albeit at a slower pace, especially for provinces that have seen exceptional wage increases recently such as Quebec, Ontario and British Columbia. (See our lead article  this month for more details.) Wage growth will support household spending.

Low interest rates, solid employment growth and immigration are also driving gains in the housing market. The adjacent graph shows solid growth in residential housing sales in 2019.

The rise of the coronavirus poses a risk to growth momentum and the benefits from the ratification of the Canada-Mexico-U.S. trade agreement and the Phase 1 deal between the U.S. and China. The virus is likely going to limit global economic growth, curtail trade and business investment during the first quarter of 2020.

The bottom line? After a cool down, growth should pick up in Canada in the second quarter of 2020. Households will be the engine of growth again this year as job creation and wages continue to increase at a moderate pace. Overall, GDP growth for the year should be slightly under-potential at a solid 1.6%.

What does it mean for entrepreneurs?

  1. Businesses operating in the commodities sector might be facing headwinds from China’s slowdown.
  2. Immigration is supporting population growth which should help businesses affected by labour shortages. It will also increase housing demand and benefit the construction industry.
  3. The loonie remains favourable for exporters, global fear of the coronavirus could weigh on Canadian exports on the short term.
U.S. economy at a glance

U.S. economy on cruise control

The U.S. economy grew by 2.1% during the fourth quarter of 2019. This brings overall GDP growth to 2.3% for the year—in line with the Federal Reserve’s expectations. While the pace of growth slowed compared to 2018, growth remains solid considering the lingering impact of the trade war with China.

The drivers of growth changed in the last quarter of 2019. Consumer spending and business investment slowed compared to prior quarters. Residential investment grew for a second consecutive quarter and exports were a major net contributor to growth.

Residential investment keeps on rising

Strong job gains and lower interest rates are spurring residential investment. New housing starts reached a 13-year high in December. Last time new construction was this high was in the mist of the housing bubble burst. The current housing market situation looks far more stable considering that the U.S. household debt ratio has been steadily declining since the last recession.

Households consumption slowed during Q4, but after two strong quarters consumers may have just been taking a breather.

The labour market continues to support household spending

The U.S. economy continues to add new jobs every month, and the unemployment rate remains close to its historic low.

Since the Great Recession, there has been a lot of slack in the U.S. labour force, but that might not be the case anymore.

Following the Great Recession, the number of discouraged workers in the U.S. reached 1.3 million. Nine years later, in December 2019, there were only 277,000 discouraged workers left (discouraged workers are those who are marginally attached to the labour force, wanting a job but not having actively looked for one in the prior four-week period).

The shrinking pool of workers to draw from should put upward pressure on wages and further stimulate household spending and housing starts, especially in this low interest-rate environment.

Have we seen the last effects of the U.S.-China trade war?

Business investment declined for a third consecutive quarter at the end of 2019, marking the longest slowdown in business investment since 2009. Most of the decline has been in non-residential structure investment, but machinery and equipment slowed as well. A slowdown in investment in the industrial sector attributable to the U.S.-China trade war is probably to blame.

The Phase 1 trade deal between the two countries should bring relief to the industrial sector and encourage business investment. However, most tariffs remain in place, so the effect of the deal is likely to be limited to improved business confidence.

Impact of the coronavirus

The coronavirus is dampening sentiment across the globe and creating fear in a number of countries, including the U.S.

It’s still too early to have a clear picture of the impact of the epidemic on the U.S. economy, but the crisis could reduce Chinese GDP growth by 0.6%, according to Oxford Economics. The slowdown in China will undoubtedly have an impact on global value chains and on the U.S. economy. The climate of fear that the virus is generating could offset the expected confidence gains from the trade deals.

What does it mean for entrepreneurs?

  1. While consumption slowed last quarter, a strong labour market and low interest rates should continue to support household spending and residential investment.
  2. Business investment slowed for a third consecutive quarter. The Phase 1 deal with China should improve business confidence, but the coronavirus adds uncertainty to the mix. Canadian entrepreneurs dealing with U.S. manufacturers should experience modest improvement.
  3. The U.S. dollar has recently depreciated following the emergence of a more stable environment. However, the coronavirus could lead investors to rush to buy safe assets like the greenback. This could lead to further depreciation of the CAD and favour Canadian exporters.
Oil market update

Where is the Canadian oil and gas sector heading?

The future of Canada’s oil and gas industry will depend on how much investment the sector can attract. Investment will have to pick-up if Canada is to remain competitive in an increasingly globalized market.

Oil and gas has generated the largest share of private sector investment in Canada since 2000. In 2014, investment in the sector peaked at $82 billion, representing 24% of total investment in Canada. Since then, with the plunge in crude oil prices, investment slowed almost every year, with the exception of 2017. Early estimates suggest investment in the sector declined 7% in 2019.

The wind is expected to turn this year. Although still a long way from the record year of 2014, investment is expected to increase by $2 billion in 2020, a 6% increase over 2019, according to the Canadian Association of Petroleum Producers. This will be a boon for the Canadian economy and even more so for oil-producing provinces that have struggled in recent years.

What is driving the expected pick-up?

The provincial governments of the two major oil producing provinces, Alberta and Saskatchewan, have announced supportive policies to spur investment in the sector.

Alberta’s United Conservative Party government eased oil curtailments in the fall and lowered the province’s corporate income tax by one percentage point in July and again on January 1. The UCP promised during the election to lower the tax rate from 12% to 8%. It now stands at 10%.

Meanwhile, the Saskatchewan government’s Growth Plan aims to increase oil production to 600,000 barrels per day by 2030, a 28% increase. The Growth Plan also highlights two new incentives to boost investment in the sector, in the form of transferable royalty/freehold production tax credits.

Moreover, optimism is growing among producers about new export pipeline capacity coming into operation. Three major pipeline projects have seen promising developments recently.

Construction on the Trans Mountain expansion restarted at the end of the summer. The Supreme Court of Canada rejected B.C.’s claim to have a say over what flows through the pipeline. The court stated that pipeline usage was unambiguously under federal jurisdiction. Earlier in February, the Federal Court of Appeal also dismissed the indigenous claim that the federal government had not been diligent in its analysis and had not adequately consulted stakeholders.

There hasn’t been a final investment decision from TC Energy on the long-delayed Keystone XL project. However, a status report filed with a U.S. court in mid-January outlined the company’s plan to start pre-construction in February and further construction development over the summer.

Elsewhere, the Canadian portion of Enbridge Line 3 replacement came into operation at the beginning of December, but the U.S. portion of the pipeline still faces delays. Nevertheless, there is hope construction of this last portion will start later this year.

Although pipelines have been the main focus for oil and gas investment in the past few years, we are also keepin an eye on the Teck Frontier project. The proposed $20.6-billion Frontier oilsands mine in northeastern Alberta is waiting for approval from the federal government later this month. The government’s decision will have important repercussions for oil and gas investment for the coming years.

Key challenges

While investment in the oil and gas sector is set to improve this year, the increase will remain modest amid low global prices, geopolitical risks and growing efforts to cut greenhouse gas emissions.

Global prices are not expected to increase much this year because of slowing demand growth and increased supply from the United States, which is partly offsetting production cuts from OPEC and its partners.

Brent is expected to average US$65 per barrel and WTI US$60. Geopolitical risks, including increased tensions in the Middle East and the coronavirus, are adding volatility to the investment outlook. On top of market challenges, decarbonization of the economy increases investors’ financial risks, regulatory difficulties and creates overall uncertainty for the energy sector.

Bottom line

We expect a modest increase in Canadian oil and gas sector investment in 2020. Provincial governments in Alberta and Saskatchewan have announced new policies and incentives that should stimulate investment. The addition of pipeline capacity along with the possibility of the Frontier project should help the Canadian oil and gas sector regain some strength.

Other economic indicators

Bank of Canada likely to remain cautious

The next meeting of the Bank Canada will be held on March 5, 2020. The overnight interest rate in Canada will most likely stay at 1.75%. The Bank will have access to fourth quarter GDP data at that point and if growth comes in lower than expected, the Bank might be tempted to push rates lower. However, we judge that unlikely given household debt levels in Canada are quite high.

The loonie back to lower levels

The Canadian dollar lost value recently hitting US$0.75. The appreciation of the greenback explains the loonie’s poor performance. The coronavirus outbreak and the rise of uncertainty and anxiety amongst investors, have made safe assets, such as the U.S. dollar, attractive investments.

Small business confidence remains weak

The confidence of Canada's small and medium-sized business (SME) owners is not starting the new decade better than the old one. The Canadian Federation of Independent Business (CFIB) Business Barometer Index dropped marginally from December to January where it stood at 55.3. Confidence is not picking up in oil-producing provinces. Overall, there was no major changes in business situations as 40% of entrepreneurs feel their business is in good shape. Pessimism is not reserved for SMEs. According to Export Development Canada (EDC), Canadian exporters are also feeling the heat of protectionism and the global economic slowdown. EDC's confidence index reached its lowest level since 2012.

Business credit conditions eased

Canadian businesses credit conditions eased over the course of January. The effective interest rates, that is the average borrowing rate faced by businesses for new lending went down by 10 basis points in a month. While rates have not moved much for households—slightly above 3.7%, the effective business rate now stands at 3.4%. As the coronavirus increased fears and generated uncertainty worldwide, demand for safer assets such as government bonds is increasing therefore decreasing the yields of those bonds. Government bonds yields movements are reflected on banks’ rates so we could see a decrease in the household effective rate making its way through the financial system in the coming month.

Key indicators—Canada