The Long and Winding Road to Recovery

Murray BenderRBC Investor & Treasury Services is pleased to present insights on topics of interest to financial institutions and corporate investors from across the globe. Today’s podcast features Dawn Desjardins, Deputy Chief Economist at RBC, presenting her latest forecast on the Canadian economy. Thank you for joining us, Dawn.

Dawn Desjardins: Thanks, Murray. Thanks for the opportunity to speak to your clients about our economic outlook.

As we’ve called it, it has a long and winding road to recovery because it has been a tremendously long 19 months since the global pandemic was announced by the WHO. And although there’s been positive developments, vaccinations, for example, coordinated policies by governments and central banks, not just in Canada, but across the world, I still don’t think we really can say that we’re in for a clear sailing to a full and widespread recovery.      

Now, for Canada, 2021 I think will prove to be a strong year for economic growth. We’re expecting the economy to grow by 5.1% this year and then we’ll almost completely recover all of the losses that were incurred in 2020. As you can see, we did see the economy contract at 5.3% last year.

But it’s not, as I say, going to be smooth. When we think back to just the second quarter of this year, you know, our economy, which had been growing at a very solid clip, suddenly shifted gears. And that really occurred in April and May, when we were going through the third wave of the virus. And it was a big wave in terms of the degree of lockdown that had to be put in place for Canada’s economy. We saw GDP output contract in both of those months. And jobs were cut.

Now, as we made our way through the other side of that wave three, we were able to reopen. And GDP increased, and we also saw employment gains recover very strongly. And July marked another bit of a detour in terms of our road to recovery. Economic output actually contracted very modestly, about a tenth of a percentage point, but indications are that for August, we are going to see a pretty robust gain.

 And so that gives us confidence that, on balance, Q3 will be a positive quarter for economic growth and we think that’s going to continue into the fourth quarter of this year and into 2022.

 And one of the key underpinnings of this view is that unlike previous waves of infection spread, we’re not going to have to see the same degree of lockdowns in our economies.

 So this chart is really looking at what have we seen historically? Well, historically, hospitalizations really did evolve significantly when we had these outbreaks of new cases. But during these previous periods, really our vaccination rates weren’t high enough, so we had to overall really close down significant parts of our economy.

We look at the current period, where yes, we are seeing new caseloads increase, we are seeing hospitalization numbers rise, but overall, our high level of vaccination means that we don’t see the same degree of lockdown measures being put into place.

And when you drill a little deeper into the data, what we’re seeing is the people who are being hospitalized, to large degrees, are unvaccinated. So, given we have such a high proportion of our population that has at least one dose of the vaccine, we think that does allow for our economy to continue to remain open. And so those industries which have been under such significant downward pressure and have had to go through these periods of significant lockdown, we think that they’re going to be able to continue to recover.

Now, just as an example, of course, we think about things of high contact, you know, when we think about our food and accommodation services. Well, as we went through June and July, we did see output in those industries improve.

Now let’s not just paint the recovery as right around the corner. In fact, that industry, we are still seeing output levels that are over 21% below pre-pandemic levels.

Now other areas of the economy are being impacted by other factors. You know, when we looked at the data as we started to get out of the deep decline that started when we had the early days of the pandemic, you know, with manufacturing and construction activity that really were moving forward, they were pulling us out of that deep decline.

And more recently, some of these industries, which again, are running at levels of output that are above where we were during the pandemic, they have come down a little bit. And this reflects other factors, sort of offshoots if you will, of the pandemic, those being supply disruptions.

Certainly, when we look at the auto industry as one example, the chip shortage, again, a very big toll on Canada’s manufacturing industries, and when we look at construction, there too, we have seen some supply shortages, but we’ve also seen significant labour market shortages. And this is certainly a factor that could weigh on some parts of our economy as this reopening continues.

Because when we look at the labour market, you know, we have come an incredible distance. When we hit that worst part of the pandemic, there were close to three million Canadians who lost their jobs. And as we’ve gone through the fits and starts of reopening, you know, we’ve certainly reduced that number. It’s still about 156,000, but what it means is that 95% of those people who lost their jobs during the worst of the pandemic, they are back to work. So that’s all good.

But when we look at it on an industry basis, we’ve seen a few trends emerge. One is that professions where you can, in fact, work remotely, we have seen significant job growth, and a lot of that, of course, in technology, in science, as well as other professional services. So that has certainly been an industry where output is running faster than where we were prior to the pandemic, and we have seen more jobs created relative to where we were in February 2020.

Now, if you go to the other end of the spectrum, however, in those industries, like I said, food and accommodation services, GDP over 21% below where it was and, of course, this is also curtailing the number of people working in that industry, about 154,000 people still missing.

Now this isn’t to say that as the economy gets on a more firm reopening path, that we won’t see these jobs being recreated, but the number of job vacancies in Canada has skyrocketed.

As of July, there were 805,000 positions that were vacant across Canada’s economy, and it really is across all sectors. Construction, for example, 68,000 positions open at this time. When we look at professional services, again, more people wanted in that industry, but the biggest shortage in terms of workers, it seems, is in the food and accommodation services industry; there, 133,000 job vacancies.

So we can see that, you know, labour numbers are down, vacancies are there, and where are the workers? And I think that’s one of the challenges businesses are facing as we go through this next phase of the reopening. You know, we know there are workers that were previously in that industry, but they’re not coming forward.

Now, in some cases, it could be that, you know, businesses are not working at the same capacity as some of the, you know, close-contact social industries, but we’ve also seen evidence that people are pivoting out of those industries, and some of the workers, that pool of workers that would normally be gravitating, aren’t in the labour market. Right now, we look at, for example, we know there are 9,000 fewer women in the labour force than there were prior to the pandemic. We know that the level of immigration has come down significantly during the pandemic. Of course, that was just another by-product of shutting down our borders, shutting down our economy. And it’s going to take some time before our immigration numbers increase enough that we can see people moving into fill some of these vacant positions.

So, for businesses, you know, they’re challenged to find workers and they’re also reporting that when they do find workers, they are seeing some intensification in terms of their demand for wages. So it is putting some pressure on some businesses here in Canada that could, in fact, delay the recovery in those industries that just can’t get the labour.

Now the other problem, as I said earlier, is the supply chain disruption. You know, the fact that some of these businesses just cannot get the input that they need and if they can get the input, the cost of these inputs has increased significantly. So when we’re thinking about what businesses are saying as they look to go forward, you know, they are expecting that they will see costs rise, that they will have to put some of this through to the consumer.     

There is a survey by the Bank of Canada. And the Bank of Canada asks people, you know, where do you think businesses—where do you think inflation will run. And they give them a bunch of ranges, I guess, of price increases. You know, 1 to 2%, 2 to 3%. And typically, you know, the majority are looking, you know, at 1 to 2, or perhaps even under 1% increase.

Well, this recent survey shows that 86% of Canadian companies expect inflation to run at 2% or greater over the next couple of years. So, definitely, businesses are also feeling some of these pressures.

Now, on the inflation side itself, we have seen Canada’s inflation rate rise. It hit 4.1% recently. That’s a pretty elevated level when we think about where we’ve been for the past decade. Now some of that increase definitely reflects what we are calling base effects, meaning when we compare the level of inflation today with where it was a year ago. And remember, a year ago we were just kind of getting our legs back under us. Now of course those rates look quite big, just by virtue of where the reopening is happening compared to where we were starting. The math in itself has pushed that inflation rate out. But when we look at other factors, you know, we’re looking at things like housing costs. When we’re looking at some things like food prices. You know, all of these components are also rising. And, in fact, when we look at the recent data of the goods and services baskets that Canadians consume, we did see that 65% of all of those products increased in their prices running hotter than 2%.

So we’ve seen some broadening out in inflation pressures in Canada. Now as we go forward, the reopening continues. We see more supply come into the market. We see some of these disruptions in terms of the supply chain ease up. We think that’s going to see the price pressures ease a little bit but still remain at about 2.5% on the headline and core measures as we go through 2022.

So for the Bank of Canada, well, it is an environment where they acknowledge, of course, these base effects on inflation. They’re not expecting that to be sustained. So they’re not looking to move immediately on interest rates. But the Bank of Canada has been out in front compared to other countries in terms of curbing some of its non-traditional measures. In fact, they are already really working towards reducing their quantitative easing program and they’re consistently doing that. And as we go forward we think that that’s going to continue, that they’ll move to a reinvestment only position in the early part of 2022.

Now in terms of the overnight rate. You know, the Bank, we think, will continue to be patient. As I said, they do think that these transitory factors will, in fact, flow through and we will see that inflation rate start to move lower towards their 2% target.

But at the same time, our economy, if it grows the way we anticipate, will be reaching its capacity limits. And we think that’s likely to be happening in the latter part of 2022. And again, that backdrop, the risks shift a little bit, that if you’re running at full capacity and inflation is a little bit higher than target, you probably want to lean against that a little bit. So we do think they’ll start to raise their policy rate and look for the overnight rate to rise to 0.75% in the second half of 2022 from 0.25% today.

Well, finally, just a word on Canada’s dollar. Now the currency has been moving around, certainly benefitting from the rise we’ve seen in energy crisis. But they—on the other side, you know, suffering a little bit during periods of volatility, and whether it’s coming through the financial market, which tends to, of course, benefit the U.S. dollar.

So, all said, the Canadian dollar has been in a relatively tight range, and we think will remain at around that $0.80 level as we go through the year ahead. The Bank of Canada, as I said, we do think will be raising the policy rate. We think the Fed will, too, but the Bank will probably be slightly more aggressive than the U.S. Federal Reserve. So a positive. But on the other side of the equation, looking for commodity prices fully to level out as that period of time. So that push and pull in terms of factors for Canada’s currency, really leaving it in this range of about $0.80 against the U.S. dollar.

Well, Murray, that’s the end of my update. Thank you so much for having me.

Murray Bender: Thank you very much, Dawn, for providing your latest economic forecast. We really appreciate it.

Dawn Desjardins: My pleasure.

Murray Bender: Today’s podcast has been brought to you by RBC Investor & Treasury Services and we hope you found it useful. For additional insights on topics relevant to financial institutions and corporate investors from across the globe, including our previous podcasts, visit I’m Murray Bender. Thanks for listening.

This content is provided for general information and does not constitute financial, tax, legal, or accounting advice and should not be relied upon in that regard. Neither RBC Investor & Treasury Services nor its affiliates accepts any liability for loss or damage arising from use of the information in this podcast.