Spending shift, business investment to help inflation fight

As inflation driven by the pandemic and the ongoing conflict in Ukraine continues to impact the economy, investors are concerned that a recession may be near.

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However, according to CIBC’s deputy chief economist, the Canadian economy is still doing “relatively OK.”

“We got very strong numbers for the first quarter and the indication is that the spring is relatively strong,” CIBC’s Benjamin Tal said. 

Further, given the pent-up consumer demand paired with the opening up of the economy, Tal said there will likely be a shift in consumption from goods to services. This is a good thing, he said, because the service sector’s supply is more elastic than supply for goods.

“In other words, it’s much easier to start a new restaurant than to establish a new manufacturing facility,” Tal said. “Therefore, the shift from goods to services that we are seeing now is actually disinflationary.”

Nevertheless, he said inflation is still a major threat to the global economy.

While the energy sector will stabilize soon, Tal said Covid-related supply chain issues have only heightened because of the ongoing Russia-Ukraine conflict and will likely remain for another year. 

Lockdowns in China have further destabilized supply chains, leading to softer global growth forecasts.

Tal said the most permanent element of inflation is the labour market. “Wages are rising, and will continue to rise, and that’s something that will be with us for a while,” he said. 

Further, rent will also continue to be inflationary as the supply of available units does not meet the demand. 

Tal said the Bank of Canada will likely raise interest rates to 2.5% from 1%, which he said will not only be significant in slowing the economy, but it will slow the housing market as well. 

But he thinks the central bank will be able to stop there.

“We believe that the reduction in inflation coming from the supply chain and the diminishing impact of energy prices on the economy means that a lot of the work on fighting inflation will be done externally,” he said.

There’s still a risk of over-tightening leading to a recession, though. Tal said if rates jump from 2.5% to 3.5%, it will make the difference between a soft landing and a recession.

“Every economic recession was helped, if not caused, by monetary policy error in which central bankers raised interest rates way too quickly and caused the recession,” he said. 

Tal also noted the impact of de-globalization on businesses. For more than 20 years, profit margins increased as a result of globalization, just-in-time inventories, and cheap and available labour, he said.

That is not the case anymore. 

“We have a situation in which just-in-time inventories are turning to just-in-case inventories, and clearly labour is not available and not cheap,” Tal said.

Instead, businesses have begun replacing labour with capital, a strategy seen in the 1990s that increased productivity, leading to lower wages and inflation. “That’s exactly what we’re starting to see now,” Tal said. 

He expects business investment to continue, which will help fight inflation: “Productivity is the number one shield from inflation,” he said.

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