Economic outlook: A return to normal in 2022?

Slight downward pressure on the Canadian dollar

The United States is one of the few developed countries where GDP has fully recovered to pre-crisis levels. The American government’s extraordinary fiscal measures supported consumption, but there is still a long way to go in terms of employment. Demand for labour is expected to continue to recover while fiscal measures are reduced and as COVID-19 concerns ease.

Increases in commodity prices, including oil, supported the Canadian dollar in 2021 at around US$0.80. Expected commodity market movements in 2022 will exert slight downward pressure—especially in the second half of the year.

However, the divergence between U.S. and Canadian interest rates should help keep the Canadian dollar close to US$0.77 despite the risk of a more urgent change of course from the Federal Reserve.

Effects of the pandemic still felt in Canada

In Canada, the pandemic appears to be largely under control for the moment.

The number of new daily cases is rising but remains fairly low. Public health mesures are being relaxed across the provinces thanks to high vaccination rates—75% of the adult population is fully vaccinated.

Despite this rather enviable situation, Canadian economic activity is still facing the adverse consequences of the pandemic, which will continue well into 2022 and consequently moderate growth in the country.

The Canadian economy is expected to continue to grow, but the gains will be more modest than could be expected at this point in the business cycle.

Consumer demand: main engine of growth in Canada

Canadian households will remain the key to economic recovery in 2022. The savings they accumulated during the pandemic positions them well to support the economy and has provided them with a small cushion to absorb inflation. However, their consumption habits are expected to return to normal as restrictions on the services sectors gradually ease.

Residential investment will contribute positively to growth again in 2022. Despite tight inventories, the resale market could experience a wave of transactions at the beginning of the year. Some buyers who anticipate higher interest rates may be more aggressive in order to lock in lower rates.

The frenzy will slow as the Bank of Canada raises rates. That will be the case for housing starts as well.

The momentum of early 2021 continues to fade for the residential sector, but demand remains strong and housing starts will remain at high levels.

A powerful impetus from commodities

Canada’s growth will benefit from strong global demand for commodities. Commodity prices skyrocketed during the COVID-19 pandemic and are expected to remain at high levels for most of 2022, but a downtrend is emerging amid a Chinese industrial slowdown. A shift from goods spending to services spending will further temper demand.

Oil is expected to remain high in early 2022. Once the northern hemisphere winter is over and thanks to the continuous but gradual increase in supply by producing countries, prices are expected to fall slightly and return to levels similar to those seen before the pandemic.

Shortages: a bottleneck for growth

The rapid rebound in demand for raw materials, intermediate goods and various logistics services has been hampered by limited supply. This has hit several markets and is translating into exceptional price increases and late deliveries that are putting pressure on many supply chains.

The problems created by these bottlenecks will persist for much of 2022. Unable to obtain the productive capital and inputs needed for their operations, many companies have slowed or stopped production altogether.

Global supply chains have become so complex that it is difficult for them to recover from a disruption. As we saw with the blockage of the Suez Canal for 10 days in 2021, a seemingly limited disruption can have an infinitely larger impact on the system as a whole. This includes when a port shuts down due to a COVID-19 outbreak or when a plant shuts down to ration energy.

When bottlenecks affect upstream products, such as energy products and metals, the scarcity of these products will lead to greater spillover effects by restricting the production of other goods.

Labour shortage: a strong trend that will continue

Canadian production is not only limited by physical inputs, but also faces a severe labour problem.

Scarcity, shortage, skills match… the labour market challenges facing Canadian businesses will persist in 2022.

As a result, employment gains will be increasingly difficult to achieve, especially for high-contact service sectors (accommodation, food services, etc.) that require large numbers of workers. Although the share of GDP that remains to be recovered to reach the pre-pandemic peak is mostly in these sectors, their productive capacities changed during the pandemic and the return to normalcy will be more complicated for them.

Transitory or structural inflation?

Inflation is a growing concern for economic observers. It must be said that the base effect increased the inflation rate last year, because prices, particularly energy prices, dropped dramatically at the very beginning of the COVID-19 crisis. Some of the price increases observed in the past year can therefore be attributed to a return to normal.

Despite that effect, there are in fact price increases. The recent strength in inflation is being driven by soaring energy prices, rebounding demand for more recently reopened services, supply chain problems, container shortages and labour shortages.

It is important to distinguish short-term or transitory inflationary pressures from those that are systemic and structural. Current inflationary pressures remain transitory, but are weighing more heavily on the outlook and will last longer than initially anticipated.

Inflation is expected to return to more sustainable levels only by the end of 2022. By then, the Bank of Canada will have already begun tightening monetary policy in order to cool things down.

The rise in the inflation rate will therefore increase financing costs. Of course, credit conditions will remain favourable and affordable in the near future as these increases are phased in over time.

Robust growth despite increased pressure on capacity

After one of the most severe recessions in history in 2020, the economic recovery began quickly in 2021 thanks to effective vaccination efforts. While economic activity in some developed countries has already fully recovered, the Canadian economic outlook for 2022 is proving to be a little more complicated and the return to normal will be a little slower.

Again this year, growth will be limited by spillover effects from the pandemic.

Demand will remain strong as households reallocate some of their spending from consumer goods to services. Supply will continue to adjust accordingly, but pressure on supply chains could create a desynchronization of supply and demand that would negatively impact growth. Labour shortages and inflation will also continue to limit growth.

The Canadian economic outlook for 2022 is nevertheless encouraging. We should return to pre-pandemic GDP levels in the first few months of the new year, although several factors that contributed to the slowdown in the second half of 2021 will weigh more heavily on the recovery. It is clear that the evolution of the pandemic remains the biggest uncertainty for these forecasts.

Download the Canadian Entrepreneurs’ 2022 Investment Outlook for a more detailed look at the drivers of business investments for the next 12 months.