Key Takeaways
- Despite the setback from third and fourth waves of COVID-19 in 2021, the Canadian economy is still on course to expand by a robust 5.0% in 2021, and 2022-2023 will likely bring another couple of years of above-potential growth.
- There are numerous risks to our baseline growth forecast. The delta variant may not represent the virus' last assault and higher- and longer-than-expected inflation could derail the domestic demand from a robust growth path.
- Our forecast is that consumer price inflation in Canada will peak this quarter and the next (on a year over year basis) before reverting in the second half of 2022 to its 2% average, in line with Bank of Canada's (BoC) target. We continue to see inflation as a specific feature of the pandemic crisis that will fade away along with pandemic disruption.
- Given elevated inflation (above the BoC's target band) in the first quarter and our forecast of total employment recovering to full employment trend by the first quarter of 2022, we now anticipate the BoC will begin its rate hike cycle in April 2022 (versus market pricing of as early as January 2022 and BoC's "sometime in the middle quarters of 2022").
An improving health situation in Canada amid vaccination progress has led to stable mobility, reinvigorated demand for services, and stronger hiring. Still, several government support programs were withdrawn in the fourth quarter, labor and capital supply constraints will linger into next year, and elevated inflation will eat into purchasing power. We have lowered our GDP growth forecasts by 0.4 percentage points (ppt) to 5.0% in 2021 and by 0.1 ppt to a still strong 3.7% in 2022. However, we have raised our 2023 growth forecast by 0.4 ppts to 2.7% and 2024 growth by 0.2 ppts to 2.1%, as the gradual clearing of current global growth headwinds and additional public investment by the newly re-elected government buttress stronger advances(1). Taken together, the revisions to annual GDP growth sum up to a GDP trajectory that brings the Canadian economic output to a level more or less consistent with our earlier forecasts published this year (see chart 1).
Chart 1
Implicit in our baseline forecast is that the drag on spending from COVID-19 will continue to wean. High vaccination rates should obviate the need for major social restrictions going forward. That said, downside risks to our baseline growth forecasts from COVID-19 can't be brushed off just yet. The delta variant may not represent the last assault by the virus and worsening fatalities could reverse some reopening trends domestically (especially in light of the current sweeping wave of COVID-19 in Europe). Moreover, given close to one-third of Canadian GDP is based on exports (versus less than one-eighth in the U.S.), weaker than expected output growth could persist not just due to policy choices made domestically but also by governments overseas.
The new omicron variant is a stark reminder that the pandemic is far from over. Although already declared a variant of concern by the World Health Organization, uncertainty still surrounds its transmissibility, severity, and the effectiveness of existing vaccines against it. Early evidence points toward faster transmissibility, which has led many countries to close their borders with Southern Africa and/or raise travel restrictions to some degree. Over the coming weeks, we expect additional evidence and testing will show the extent of the danger it poses. Meanwhile, the omicron variant's appearance has jolted confidence and we can expect a precautionary stance in markets, as well as further containment measures, until more accurate information becomes available. At this stage, it is once again evident that more coordinated and decisive efforts will be necessary to vaccinate the world's population to prevent the emergence of new, more dangerous variants.
Table 1
| S&P Global Canada Economic Forecast Overview | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| November 2021 | ||||||||||||||
| 2019 | 2020 | 2021f | 2022f | 2023f | 2024f | |||||||||
| Real GDP (year % ch.) | 1.9 | (5.3) | 5.0 | 3.7 | 2.7 | 2.1 | ||||||||
| (September GDP forecast) | 1.9 | (5.3) | 5.4 | 3.8 | 2.3 | 1.9 | ||||||||
| Household real final consumption (year % ch.) | 1.7 | (5.9) | 4.1 | 4.8 | 3.0 | 2.2 | ||||||||
| Real equipment investment (year % ch.) | 1.0 | (17.4) | 7.5 | 8.6 | 5.4 | 3.2 | ||||||||
| Real nonresidential structures investment (year % ch.) | 1.1 | (11.3) | (4.7) | 6.3 | 5.3 | 3.2 | ||||||||
| Real residential investment (year % ch.) | (0.2) | 4.1 | 18.1 | (3.4) | (0.2) | 1.7 | ||||||||
| Core CPI (year % ch.) | 2.1 | 1.1 | 2.2 | 2.5 | 1.7 | 2.0 | ||||||||
| Unemployment rate (%) | 5.7 | 9.6 | 7.6 | 6.3 | 5.9 | 5.6 | ||||||||
| Housing starts (annual total in thousands) | 208.3 | 219.0 | 275.3 | 239.2 | 230.0 | 227.5 | ||||||||
| MLS house price index (year % ch.) | 1.2 | 8.5 | 21.0 | 2.8 | 0.0 | 1.7 | ||||||||
| 10-year government bond yield (%) | 1.6 | 0.8 | 1.4 | 2.3 | 2.9 | 3.1 | ||||||||
| Bank of Canada policy rate (year-end %) | 1.8 | 0.6 | 0.3 | 0.6 | 1.1 | 1.6 | ||||||||
| All "year % ch." are annual averages percent change. Core CPI is consumer price index excluding energy and food components. f--forecast. Sources: Statistics Canada, Oxford Economics, and S&P Global Economics forecasts. | ||||||||||||||
Broad-Based Domestic Demand To Power Growth In The Coming Months
In the coming months, the declining marginal impact of COVID-19 should keep renewed business and consumer optimism intact while a resilient jobs recovery should support income growth. Household finances have stabilized along with more than C$200 billion in savings over the implied pre-pandemic trend, which will support consumer spending growth of a little under 4.1% this year and 4.7% in 2022. Increases in household savings by income quartile were broad-based, according to a recently released breakdown data by Statistics Canada--which is admittedly different from our previous assumption that the rise was likely more concentrated among the higher income households. Given the broad-based nature of Canadian excess savings, combined with a higher likelihood to consume out of each additional dollar for lower-income households, consumer spending will continue to provide an outsize proportion of growth (see chart 2)(2).
Chart 2
The gains from normalizing travel, tourism, and immigration look to provide tailwinds to growth in the next couple of years, offsetting a weaker (but higher than previously forecast) impulse from government spending. Transportation bottlenecks and shortages of semiconductors and construction materials continue to limit production in the manufacturing sectors that are important for Canadian exports, such as motor vehicles and parts and construction (see chart 3). The implicit assumption is that these supply chain disruptions will last at least mid-way through 2022, after which production in these sectors should improve. As the current supply chain wrinkles iron out, businesses will continue to rebuild depleted inventories, and nonresidential business investment outlays will contribute strongly to growth.
Chart 3
Housing activity has declined from historical highs but remains elevated (see chart 4). While multiple-unit housing starts have remained relatively robust, single family starts declined significantly from the first quarter until the trend reversed in October, indicating that the pandemic-related boost in demand for more living space is easing. Nonetheless, housing markets remain tight, and high disposable incomes and low borrowing rates should continue to support solid levels of housing activity with starts near 230,000 annually on average over the next three years. The decline in new groundbreaking would be consistent with a 3.4% residential investment decline in 2022 following outsize growth of 18% in 2021. Still, a continued healthy supply of new homes should slow price rises (MLS index) to a modest 2%-3% next year (compared to 20% in 2021), and we expect prices will stay relatively flat in the following two years as interest rates move up and cyclical demand softens further.
Chart 4
Significant uncertainty surrounds the outlook for GDP and potential output. In particular, the impacts of supply disruptions, labor market mismatches, and accelerated digital investments remain difficult to quantify. In our forecast, the output gap (the economy's output shortfall from what it could produce sustainably at full capacity) is closed by sometime in the third quarter of 2022.
Chart 5
Inflation Elevated But Likely To Move Back Down After First-Quarter 2022
Our narrative on Consumer Price Index (CPI) inflation hasn't changed from the last forecast (see "Economic Outlook Canada Q4 2021: Growth Delayed, Not Derailed" published Sept. 24, 2021)--we see headline CPI inflation peaking in fourth-quarter 2021 and first-quarter 2022 on a year-over-year basis, before moving back down within the central bank's target control range of 1%-3% in the second half of 2022. However, recent developments have prompted us to revise our level forecast of CPI inflation (on a year-over-year basis) for Canada up by a few tenths of a percentage point for the fourth quarter of this year through the third quarter of next year. CPI inflation accelerated to 4.7% year-over-year in October, up from 4.4% in September. Energy, followed by shelter, has been the main driver of headline inflation since May. Energy prices were 25.5% higher than the same period a year ago in October, with gasoline prices up a whopping 41.7%. Excluding energy, prices were up 3.3% over the same period a year ago, the same as the pace in September.
Chart 6
CPI inflation is expected to remain elevated for the rest of 2021 and into 2022 due to ongoing supply disruptions created by the pandemic and higher energy prices. There are reasons to believe that inflation will ease by the end of 2022 as some of the pressures from what are generally deemed "temporary" factors dissipate. For a start, our oil and gas sector analysts assume West Texas Intermediate (WTI) oil prices will fall to $60/barrel on average next year and $50/barrel in 2023, from $78/barrel currently. We also assume freight rates will eventually decline to more normal levels, and the prices of some goods should fall as supply constraints ease. Additionally, Canada--unlike the U.S.--uses house prices directly in CPI, meaning this component will weigh on overall price growth, given our forecast for housing activity to cool from the current unsustainable levels, which will manifest in a sharp decline in house price growth next year.
Moreover, unlike in the U.S., wage growth has been more muted in Canada, with October figures standing at 1.7% over the previous year (versus in the U.S., where the Bureau of Labor Statistics measure was 4.9% and the Federal Reserve Bank of Atlanta's was 4.1%). We foresee hourly wage growth averaging 2.7% in 2022 following a 2.5% annual average this year, a slight pickup but still on a lower track than in the U.S., where the hit to the labor supply has been larger and the potential for a rebound in immigration to alleviate labor shortage is lower. Overall, we expect Canadian CPI inflation to average 3.2% this year, 2.8% in 2022, and 1.7% in 2023.
Chart 7
Employment Levels Poised To Make Full Recovery By First Quarter
Having reached a recovery milestone in September as employment returned to pre-pandemic levels for the first time, net job creation increased further in October as payrolls rose by 31,000 and the unemployment rate fell by 0.2 ppts to 6.7%, now within 1 ppt of 2019's 5.7%. The labor market has seen a rapid improvement in recent months, reflecting the initial burst of job gains as the economy reopened. The employment level is now 0.2% above its pre-pandemic (February 2020) level and the labor force participation rate was at record or near-record highs for most age groups in October. Women and youth employment--groups hard hit by the pandemic recession--have experienced almost a complete recovery to pre-pandemic levels, easing fears of long-term scarring.
Chart 8
This rebound in Canada's labor force participation rate contrasts with "the great resignation" trend observed in the U.S., where participation has recovered less quickly. According to Statistics Canada's Canadian data adjusted to the way U.S. measures, Canada's participation rate was 65.1% in September 2021, 0.3 ppts below its February 2020 level. In the U.S., the September labor force participation rate was 1.7 ppts below its pre-pandemic level. Core employment (ages 25-54) to population--which isn't muddled by retirement forces that are also present in Canada, like in the U.S.--stood at 83.3%, on par with the February 2020 level for core men (86.6%) and core women (80%).
Additional improvement may take more time as the matching process between job vacancies and available workers unfolds. The abrupt closure and subsequent rapid reopening of the economy in each wave of the pandemic have worsened the usual search frictions in the labor market. In addition, the Canada Recovery Benefit package as well as wage and rent subsidies for businesses ended on Oct. 23, and it is not clear how Canada's labor market will react. Still, the pace of activity growth in the next four months will help the economy absorb excess labor market slack (as indicated by the employment shortfall from the pre-pandemic full employment trajectory accounting for population growth and in the absence of a COVID-19 shock) by the end of the first quarter next year.
Chart 9
Monetary Policy
In the most recent monetary policy statement, the BoC laid out a decidedly more hawkish decision to end quantitative easing-related net asset purchases immediately (it was widely expected to taper to C$1 billion per week from C$2 billion per week) and forward guidance on the timing of a likely rate hike moved from the second half of 2022 to "the middle quarters" (i.e. as early as April 2022). Moving forward, the Bank will maintain its total stock of government of Canada bonds roughly constant by reinvesting maturing assets. The BoC ended up adding about C$350 billion in government bonds since the start of the pandemic, with its total assets now standing at 18% of GDP, which is smaller than other major central banks of advanced economies.
Even with the ending of asset purchases, monetary policy remains very accommodative since the bank is not shrinking its balance sheet (either by actively selling its assets or even simply rolling off maturing assets). In addition, given the higher inflation rate, policy rates in real terms have arguably become even more accommodative (declined to -3% once adjusted for current inflation measure, see chart 11). Assuming elevated inflation will persist through the first quarter of next year and our forecast of total employment recovering to full employment trend by the same quarter, we now anticipate the BoC to begin lifting policy rates in April 2022 (versus market pricing of as early as January 2022 and BoC's "sometime in the middle quarters of 2022").
Chart 10
Chart 11
Table 2
| S&P Global Economic Outlook--Canada Baseline Assumptions | ||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| --2021-- | --2022-- | 2018 | 2019 | 2020 | 2021f | 2022f | 2023f | 2024f | ||||||||||||||||||||||||
| 1Q | 2Q | 3Q | 4Q | 1Q | 2Q | 3Q | 4Q | |||||||||||||||||||||||||
| Real GDP and components* | ||||||||||||||||||||||||||||||||
| GDP growth | 5.5 | (1.1) | 3.9 | 5.5 | 4.6 | 2.9 | 3.6 | 2.7 | 2.4 | 1.9 | (5.3) | 5.0 | 3.7 | 2.7 | 2.1 | |||||||||||||||||
| Final domestic demand | 6.5 | 0.7 | 0.3 | 8.2 | 5.4 | 2.5 | 3.7 | 2.3 | 2.5 | 1.4 | (4.3) | 5.3 | 4.0 | 2.3 | 2.0 | |||||||||||||||||
| Household final consumption | 2.3 | 0.3 | 4.5 | 6.8 | 5.5 | 4.4 | 4.1 | 3.5 | 2.5 | 1.7 | (5.9) | 4.1 | 4.8 | 3.0 | 2.2 | |||||||||||||||||
| Government final consumption | 6.9 | 6.1 | 4.2 | 1.0 | 1.0 | 1.0 | 0.9 | 0.9 | 2.9 | 2.0 | (0.3) | 6.0 | 1.7 | 0.8 | 0.8 | |||||||||||||||||
| General government gross fixed capital formation | 8.1 | (7.7) | 4.2 | 8.8 | 9.9 | 5.5 | 4.1 | 4.1 | 4.3 | 0.3 | 4.1 | 5.5 | 5.9 | 3.4 | 0.8 | |||||||||||||||||
| Business gross fixed capital formation | 18.7 | (2.2) | (6.8) | 3.7 | 2.0 | 3.5 | 1.9 | 2.9 | (3.5) | 2.8 | (0.9) | 2.9 | 2.6 | 2.8 | 2.5 | |||||||||||||||||
| Residential construction | 42.1 | (12.4) | (7.2) | (2.0) | (2.1) | (1.8) | (2.5) | (2.0) | (1.7) | (0.2) | 4.1 | 18.1 | (3.4) | (0.2) | 1.7 | |||||||||||||||||
| Non-residential construction | 1.9 | 5.1 | 0.0 | 9.4 | 5.9 | 8.3 | 5.7 | 6.9 | 2.7 | 1.1 | (11.3) | (4.7) | 6.3 | 5.3 | 3.2 | |||||||||||||||||
| Machinery and equipment purchases | (16.7) | 24.9 | 8.9 | 9.5 | 6.0 | 8.4 | 5.8 | 7.0 | 3.7 | 1.0 | (17.4) | 7.5 | 8.6 | 5.4 | 3.2 | |||||||||||||||||
| Intellectual property products | 18.7 | 3.3 | (18.2) | 9.7 | 6.1 | 8.6 | 5.9 | 7.2 | 6.8 | (3.0) | (2.1) | 2.4 | 7.0 | 4.1 | 3.3 | |||||||||||||||||
| Total exports | 3.3 | (15.0) | 11.1 | 5.1 | 11.1 | 10.8 | 6.2 | 5.7 | 3.7 | 1.3 | (10.0) | 2.0 | 7.1 | 5.2 | 2.9 | |||||||||||||||||
| Total imports | 4.3 | (0.1) | (4.0) | 14.3 | 13.3 | 9.0 | 6.5 | 4.1 | 3.4 | 0.4 | (11.2) | 6.3 | 8.1 | 3.8 | 2.3 | |||||||||||||||||
| Other economic indicators | ||||||||||||||||||||||||||||||||
| CPI inflation (%) | 1.5 | 3.3 | 3.9 | 4.2 | 4.1 | 3.2 | 2.4 | 1.6 | 2.2 | 2.0 | 0.7 | 3.2 | 2.8 | 1.7 | 2.2 | |||||||||||||||||
| Core inflation (%)§ | 1.1 | 2.1 | 2.9 | 2.8 | 3.3 | 2.6 | 2.2 | 2.0 | 1.9 | 2.1 | 1.1 | 2.2 | 2.5 | 1.7 | 2.0 | |||||||||||||||||
| Employment (000's) | 18,545.8 | 18,658.8 | 18,996.4 | 19,180.8 | 19,313.7 | 19,419.1 | 19,505.9 | 19,578.6 | 18,569.4 | 18,979.1 | 18,004.5 | 18,845.5 | 19,454.3 | 19,720.8 | 19,950.5 | |||||||||||||||||
| Employment (%y/y) | (1.3) | 12.0 | 5.1 | 3.7 | 4.1 | 4.1 | 2.7 | 2.1 | 1.6 | 2.2 | (5.1) | 4.7 | 3.2 | 1.4 | 1.2 | |||||||||||||||||
| Unemployment rate (%) | 8.4 | 8.0 | 7.2 | 6.8 | 6.6 | 6.4 | 6.2 | 6.2 | 5.9 | 5.7 | 9.6 | 7.6 | 6.3 | 5.9 | 5.6 | |||||||||||||||||
| Average hourly earnings (%y/y) | 4.8 | 0.9 | 1.9 | 2.5 | 1.9 | 2.0 | 3.2 | 3.6 | 3.3 | 2.7 | 4.8 | 2.5 | 2.7 | 2.4 | 2.6 | |||||||||||||||||
| Household credit market debt (%y/y)† | 4.2 | 6.7 | 2.8 | 2.7 | 3.3 | 1.5 | 4.5 | 4.3 | 3.8 | 4.0 | 3.9 | 2.7 | 4.3 | 3.6 | 3.9 | |||||||||||||||||
| Household credit market debt (% of disposable income)† | 173.5 | 174.5 | 168.6 | 176.3 | 176.0 | 175.3 | 175.1 | 175.4 | 183.0 | 182.6 | 175.6 | 176.3 | 175.4 | 175.5 | 175.5 | |||||||||||||||||
| Bank of Canada Overnight Rate (%) | 0.3 | 0.3 | 0.3 | 0.3 | 0.3 | 0.5 | 0.8 | 0.8 | 1.4 | 1.8 | 0.6 | 0.3 | 0.6 | 1.1 | 1.6 | |||||||||||||||||
| Government of Canada three-mth T-bill yield (%) | 0.1 | 0.1 | 0.2 | 0.2 | 0.2 | 0.5 | 0.7 | 0.7 | 1.4 | 1.7 | 0.4 | 0.1 | 0.5 | 1.2 | 1.7 | |||||||||||||||||
| Government of Canada 10-yr bond yield (%) | 1.2 | 1.5 | 1.2 | 1.7 | 1.9 | 2.2 | 2.5 | 2.7 | 2.3 | 1.6 | 0.8 | 1.4 | 2.3 | 2.9 | 3.1 | |||||||||||||||||
| Exchange rate, USD-CAD (period average) | 1.3 | 1.2 | 1.3 | 1.3 | 1.2 | 1.3 | 1.3 | 1.3 | 1.3 | 1.3 | 1.3 | 1.3 | 1.3 | 1.2 | 1.2 | |||||||||||||||||
| Exchange rate, USD-CAD (end of period) | 1.3 | 1.2 | 1.3 | 1.2 | 1.3 | 1.3 | 1.3 | 1.3 | 1.4 | 1.3 | 1.3 | 1.2 | 1.3 | 1.2 | 1.2 | |||||||||||||||||
| Current account balance (% of nominal GDP) | 0.3 | 0.6 | 1.4 | 0.3 | (0.6) | (0.5) | (0.7) | (0.7) | (2.3) | (2.1) | (1.8) | 0.7 | (0.6) | (0.7) | (0.9) | |||||||||||||||||
| Merchandise trade balance (% of nominal GDP) | 0.2 | 0.3 | 1.6 | 0.8 | (0.1) | 0.2 | 0.0 | 0.0 | (0.9) | (0.7) | (1.7) | 0.7 | 0.0 | (0.1) | (0.2) | |||||||||||||||||
| Crude oil (US$/bbl, WTI) | 57.8 | 66.1 | 70.6 | 75.4 | 72.0 | 65.2 | 58.7 | 54.2 | 64.8 | 57.0 | 39.3 | 67.5 | 62.5 | 51.4 | 50.0 | |||||||||||||||||
| Household saving rate (%) | 13.0 | 14.2 | 13.9 | 8.7 | 8.2 | 8.2 | 7.9 | 7.5 | 0.8 | 1.4 | 14.5 | 12.5 | 7.9 | 6.8 | 6.5 | |||||||||||||||||
| Housing starts (000's) | 76.4 | 69.9 | 65.7 | 63.3 | 61.6 | 60.3 | 59.2 | 58.1 | 213.6 | 208.3 | 219.0 | 275.3 | 239.2 | 230.0 | 227.5 | |||||||||||||||||
| Government fiscal balance (% of nominal GDP)‡ | (5.2) | (6.4) | (9.0) | (2.7) | (2.7) | (2.4) | (2.4) | (2.8) | 1.0 | 1.0 | (10.2) | (5.8) | (2.6) | (2.9) | (2.9) | |||||||||||||||||
| *Chained (2012) dollars, quarterly change annualized and year-over-year growth for annual data. §Total CPI excluding food and energy. †Households excluding non-profit institutions serving households (NIPSH) at quarter and year-end. ‡Net lending/borrowing by federal, provincial and local governments. f--Forecast. Q--Quarter. CPI--Consumer price index. Source: S&P Global Economics. | ||||||||||||||||||||||||||||||||
Notes
(1) The newly re-elected Liberals campaigned on C$78 billion in new spending over the next five years, accompanied by C$26 billion in new revenue-raising measures. The Liberals once again hold a minority government and are likely to compromise with the New Democratic Party in line with additional spending and tax measures.
(2) According to the Bank's second-quarter Survey of Consumer Expectations, Canadians earning more than $100,000 per year--equivalent to the top 10% of earners--intend to spend 38% of their extra savings. Those earning less than $40,000 said they intend to spend 27% of their extra savings, while those earning between $40,000 and $100,000 intend to spend 34% of their savings. See more in https://www.bankofcanada.ca/2021/07/canadian-survey-of-consumer-expectations-second-quarter-of-2021/
This report does not constitute a rating action.
| Senior Economist: | Satyam Panday, New York + 1 (212) 438 6009; satyam.panday@spglobal.com |
| Research Contributor: | Debabrata Das, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai |
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