Economic Forecasts Still Muddied by Virus, Inflation

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Benjamin Tal, deputy chief economist, CIBC.

When it comes to 2022, we have to discuss the tug of war between the virus and the economy. So we have a situation in which the WHO is now thinking what they will do when they run out of Greek letters to name the new variants. So clearly they’re thinking about the possibility of another wave, and that’s the reality that we have to live with.

It seems that 2022 will be the year in which we move from a pandemic situation to an endemic situation. We’ll have to learn to coexist with the virus. And I think this move will be roughly in the spring of 2022. Let’s pray and hope that that’s the case. If that’s the case, then I think it’s reasonable to assume that the strong economic growth that we expected in the second half of 2021, that didn’t really happen due to Delta, might happen in the spring and summer of 2022. So we expect overall economic growth to be relatively strong next year, around 4%, fueled by the consumer, the pent up demand by households and you will see a significant increase in spending.

In addition, we have to remember that businesses are sitting on a mountain of cash, roughly $300 billion of excess cash. We hope that they will start investing that money because if they don’t invest now, I don’t know when they will invest. And this kind of investment will lead to better economic growth and also some improvement in productivity that has been actually going down over the past few years. So we expect both the consumer and businesses to spend and to compensate for the lack of support coming from the government, which until now was the only game in town. So that’s basically the story when it comes to the macroeconomic story.

Now, when it comes to employment, we already are at the 2019 level. Now, it doesn’t mean that that’s where we should be because it’s a year and a half ago, and therefore we need to be about 250,000 jobs ahead of this level. So we are still in a need to see more job growth and the decline in the unemployment rate. The fact that the government will end assistance, might lead to some acceleration in job creation, especially among young individuals with low wages.

Because we have seen a situation in which until now many of them basically stayed home and did not go back to work. Why? Because the government is paying you to stay home. The minute that stops, as we have seen in other countries, many of them will come back to the labour market. And that will be actually a positive development, because at this point we are facing a significant shortage of labour, and that’s one of the reasons why wages are rising and they’re rising very fast.

Talking about wages, we must discuss the elephant in the room, and that elephant of course is inflation. And let’s admit that nobody, nobody knows where inflation will be six or eight months from now. Nobody knows, including the Bank of Canada and the Fed. So what we have to do is to look at what are the sources of those inflationary pressures and see what makes sense and what doesn’t. Wages is one source and that will continue to be the case for a while. The other source of course, is demand that will be rising. And the third one, which is extremely important, is the supply chain.

We all are aware of the situation and it’s not just supply issues, it’s the fact that there is a huge increase in demand in a very short period of time. And therefore we are experiencing a demand shock, especially for durable goods and a supply shock, and that’s why prices are rising by 7-8%. Of course, it will not stay at 7-8% because this is the year-over-year change. But if you look at the overall trajectory over the next year, it seems that inflation will be higher than the level that the Bank of Canada and the Fed will like to see, which is around 2%. This means that although they will be tolerating this kind of inflation, they also will be starting to raise interest rates in order to get ahead of the curve.

Now, something big happened over the past few weeks. With the Bank of Canada now expected by the market to hike no less than six times in 2022 and one more time in 2023. This is a huge change because until recently, people were talking about the Bank of Canada moving in 2023. I’m not sure that the market will get it right, because six moves in one year is a very, very significant adjustment to monetary policy. I’m not sure that the Bank of Canada will like to go with it, because if you move too quickly, that can derail the economy. Remember the enemy of the economy is not higher rates, it is rapidly rising interest rates.

So we see interest rates actually rising, but on a more gradual basis, maybe three moves in 2022 and another three moves in 2023. And the ultimate number will be maybe the bank rates rising from the current rate of 25 basis points to maybe 2-2.5%, which is more or less where it belongs. Inflation will rise in the next year. It will remain above 3%, but we see it going back to roughly 2-2.5% by 2023.