Economic forecast provided by Alberta Central Chief Economist Charles St-Arnaud
- With the vaccination campaign making good progress, many provinces are removing many of the COVID-related restrictions. This will allow economic activity in the hardest-hit sectors of the economy to normalize.
- The Delta variant is the main risk to the economic outlook. However, the high level of immunization rate is likely to lead to reduced hospital admissions and death. As a result, we believe that restrictions are likely to be milder than in previous waves, resulting in a smaller impact on economic activity. Nevertheless, the situation requires close monitoring.
- Growth in the coming quarters will be driven by a normalization in economic activity in the hardest-hit sectors as restrictions are lifted, and an increase in consumer spending, especially on services.
- As a result, employment will also increase robustly, leading to a steady decline in the unemployment rate. However, some labour shortage is likely, especially as weak immigration during the pandemic has led to a smaller workforce than otherwise would have been the case.
- Inflation is expected to remain above the Bank of Canada’s (BoC) target range until mid-2022 due to a base effect and temporary price pressures owing to supply-chain disruption, higher commodity prices and a surge in transportation cost. Whether those temporary factors permanently affect inflation will depend on whether they lead to a rise in inflation expectations and wage growth.
- With economic activity normalizing and the amount of slack in the economy resorbing rapidly, there is less need for an extraordinary level of policy support for growth. Accordingly, we expect the BoC to stop its net purchases of government bonds before the end of the year and to hike its policy rate by 0.25% at the July 2022 meeting.
- Alberta is set to have the strongest growth rate amongst Canadian provinces in 2021, in part due to the strong tailwind coming from higher energy prices and stronger momentum as the economy had a deeper contraction in 2020.
With robust economic activity and employment growth, we expect the unemployment rate to continue to ease but to remain above the national measure.
- A fourth wave of COVID infections is the main downside risk to the outlook. As such, we note that the vaccination rate in some regions of the province remains worryingly low, making them vulnerable to the Delta variant, and susceptible to new restrictions and weaker economic activity.
A final reopening phase
With the vaccination campaign making significant strides, many provinces have significantly reduced the restrictions on economic activity. This means that the hardest-hit sectors will finally be able to grow with minimal constraints and normalize their economic activity and employment level. Therefore, we take this opportunity to update our economic outlook for Canada and Alberta.
It is important to note that our outlook is based on the assumption that the reopening of the economy goes relatively smoothly and the increase in COVID cases remains contained.
The Delta variant is a risk
The main risk to our scenario remains a resurgence in COVID-19 infections. International experience has shown that many countries are seeing a surge in infections as the restrictions on activity are removed, especially due to the more transmissible delta variant. However, the rise in cases and hospitalizations mainly affects the unvaccinated part of the population, suggesting that vaccines remain efficient at preventing infections and complications. As a result, Canada’s high immunization level should help contain a fourth wave of infections.
While vaccinated people can still get infected, the likelihood of hospitalization is significantly reduced with immunization. The last point is important. The restrictions to slow the spread of COVID-19 were mainly put in place to safeguard the health care system. As the vaccination significantly reduces the likelihood of hospitalization and death, restrictions will likely be milder than in previous waves, meaning that the impact of economic activity will also be more minor.
Even without new restrictions, consumers are rational and are likely to modify their behaviour if cases increase rapidly in their area. As a result, growth in the third quarter and fourth quarter is expected to be slightly negatively affected by a rise in COVID cases. Nevertheless, the situation requires close monitoring and a fourth wave, most likely in the fall, could delay the recovery.
The pandemic-induced recession has been one of the deepest yet shortest in Canada’s history, with the level of economic activity declining by almost 20% between February and April 2020. Since the recovery started in May 2020, the level of economic activity has increased rapidly and is now only 1.2% below its pre-pandemic level.
Comparing the current recovery to others since 1980, the current recovery is the fastest. Five quarters into the recovery, the level of economic activity (the GDP level) is slightly above where it was at this point during other recoveries, despite a more significant contraction. Moreover, it is expected that the activity level will surpass its previous peak earlier than during other recoveries. This is not a small feat considering the initial shock was almost three times the output loss during the 1980 recession or the global financial crisis.
The next phase of the recovery will be characterized by a rotation in the source of growth. On the industry side, the strong contribution from real estate, finance, professional services, and other sectors that more easily adapted to working from home, will be less important. A significant share of growth is expected from the hardest-hit industries, as constraints on their activities are lifted, allowing those sectors’ level of activity to converge rapidly towards the pre-pandemic level. However, the level of activity in the hardest-hit sectors may remain below their pre-pandemic for some time. For example, the lack of international travellers may hold back somewhat the tourism industry.
We expect growth to reach 6.1% in 2021 and 3.9% in 2022, after a contraction of 5.3% in 2020. We also estimate that the level of Canadian economic activity will surpass its pre-pandemic peak in 2021Q3, marking the expansion phase of the economic cycle.
The current employment recovery is also the strongest since the 1980s. Despite much more significant job losses, the level of employment in the current recovery is in line with where it was at this point in other recoveries. We estimate that employment will likely be back to its pre-COVID level before the end of the summer or about eighteen months after the recession started, much faster than any other recoveries since 1980.
As growth accelerates and the economy reopens over the summer, employment will also increase significantly. However, the increase will be driven mainly by the normalization of activity in the hardest-hit sectors playing catch-up to the rest of the economy.
Already, the unemployment and underemployment rate are at or close to their lowest level since the start of the pandemic. With the strong job gains expected in the coming months, the unemployment rate is expected to moderate and reach 6.5% by the end of the year and 5.9% by the end of next year.
Some concerns remain in the labour market. About 1 in 4 unemployed have been out of work for more than six months (in Alberta, this proportion is almost 1 in 3), which could reduce their hiring potential. However, many of those workers are also likely in sectors deeply affected by the pandemic, like accommodation and food services, and are likely to be needed as activity normalizes in the industry.
Labour shortage as the economy reopens is another concern. A shortage of skilled labour is already mentioned as an issue by many businesses. Moreover, as we have seen in the US, labour shortages have also affected the lower wage and less skilled segment of the labour market. Part of the shortage in the US is the result of workers having left the labour force due to the pandemic, and are not yet comfortable or willing to come back to work.
In Canada, the participation rate has declined much less than in the US, suggesting that this issue is less of a problem. Moreover, looking at the number of workers out of the labour force but wanting to work, we find that it is only about 60-70k bigger than pre-COVID. However, some of those workers are not readily available for work. Some are out of the labour force because of illness, personal or familial responsibility, or back to school. Once those workers are taken into account, we find that about 50k workers outside the labour force are immediately available, or about 0.2% of the labour force.
The lack of workers in Canada comes mainly from the sharp decline in immigration since the start of the pandemic. This has resulted in weak working-age population growth over the period. We estimated that the labour force is smaller by at least 200k workers because of this and will continue to grow at a slower pace as long as restrictions on new arrivals persist. Put differently, there are at least 200k workers missing to fill the current job postings. This could potentially create some acute labour shortage, especially in sectors employing newly arrived migrants.
A smaller pool of working-age workers suggests that in the event of acute labour shortage, increasing wages may have little impact to attract workers since few available workers can take employment and be enticed to come to the labour force to take a higher pay.
Consumption, housing and household debt
On the consumer side, we expect a sharp increase in spending. However, there will also be a rotation in the consumption patterns. After spending mainly on durable goods during the pandemic, households are likely to shift a significant proportion of their consumption towards services, especially going out and travelling.
The strength of the pickup in consumer spending will also depend on whether household will spend their savings accumulated during the pandemic. We estimate that households have saved about $320bn during the pandemic, about $160bn of which is in bank accounts easily accessible with a debit card. To put this amount into context, it would cover more than 10% of household spending in 2019.
A recent survey by the Bank of Canada suggests that consumers are likely to use about 35% of their pandemic savings to increase spending over the next two years. About 45% will be kept as precautionary spending and the balance will be used to repay debt or for a down payment on a home. The same survey also shows that most of the increase in spending will be on restaurants, going out and other social activities, and on travel, sectors that have been the hardest-hit by the pandemic.
The housing market boomed in late 2020 and early 2021. While activity is expected to moderate from record levels in the coming months, the sector should remain strong. Continued low interest rates and changing housing preferences remain powerful catalysts. However, high prices in many regions are starting to curb demand. Moreover, some cooling should be expected, as would-be sellers enter the market to profit from higher prices.
As we have noted previously (see Rising Interest Rates to Make Many Canadian Cities Unaffordable), record low interest rates have been keeping affordability high in many regions, despite the sharp rise in prices. However, as monetary policy normalizes and rates increase, affordability is expected to deteriorate rapidly, especially in Toronto, Ottawa, Vancouver and Montreal, leading to under performance in the housing sector in those cities. On the other hand, the markets of Calgary and Edmonton are much more affordable and less sensitive to rising interest rates.
The strength in the housing market has also led to a continued increase in household debt, pushed higher by a rapid increase in mortgage debt. Despite the continued rise in household debt, the debt-to-income ratio and the debt-service ratio remain lower than before the pandemic due to the higher disposable income. The high level of household debt is not an issue per se. The problem is that it makes households more vulnerable to shocks, like a rise in interest rates or a decline in income.
Inflation has been above the BoC’s 2% target for most of 2021 and it is expected to remain the case until early 2022. Many factors explain the high inflation rate. First, a powerful base effect has been pushing inflation higher since April 2021 and we estimated that it would push the inflation rate by between 0.5 and 1.5 percentage points over the next year.
In addition, supply chain bottlenecks are also causing shortages of some products, notably electronic chips. Similarly, transportation costs have surged as a shortage of empty containers hits shipments out of Asia. Moreover, commodity prices have also increased significantly since the beginning of the year, increasing input costs for many businesses. All of those factors will likely translate into higher output costs.
All those inflation pressures should, in theory, be temporary. The base effect will disappear once the base year changes. At some point, supply and demand will adjust and the supply bottlenecks will ease. The mislocation of empty containers will be resolved. However, ‘temporary’ in this case may be longer than some would normally think, as those temporary factors are likely to impact inflation for the next two years.
Whether those temporary factors have a more permanent impact on inflation will depend on whether inflation expectations start to rise due to the higher observed inflation and whether it leads to stronger wage growth. This is the reason the BoC has been keen on reminding Canadians that they view the current high inflation rate as temporary. Accordingly, they hope to prevent a rise in inflation expectations, allowing them to keep their loose monetary policy longer to support the recovery. At this point, we believe that we are likely to see some positive impact on inflation expectations but that any increase will remain contained.
We project inflation will remain above 3% until early 2022 before easing somewhat in the second half of the year. Nevertheless, inflation is expected to remain above 2% until early 2023.
Whether higher inflation is a negative risk to the economic outlook will depend on whether it leads to a decline in real household income. Moreover, higher inflation will lead to higher interest rates, all else equal. Considering the level of debt, this will increase households’ debt burden and the share of their income used to service that debt, forcing them to reduce their discretionary spending. However, an increase in inflation could lead to higher nominal income if wage growth accelerates and could somewhat offset the increase in debt payments.
Economic support will be scaled back
With economic activity normalizing and the amount of slack in the economy resorbing rapidly, there is less need for an extraordinary level of support for growth. With this in mind, we believe the BoC will continue to scale down its asset purchase program (quantitative easing). As such, we think the BoC could stop net purchases of government bonds before the end of 2021 and enter what could be called the reinvestment phase (a period where the central bank only buys government bonds to replace those that mature, keeping its holdings constant).
On the policy rate side, with the economy expected to start to expand beyond its pre-pandemic peak starting in 2021Q3 and the unemployment rate on a gradual decline, there will be gradually less reasons for the BoC to keep its policy rate at the emergency level of the effective lower bound of 0.25%.
We believe that the BoC will start to increase its policy rate once the unemployment rate reaches the low 6%, signalling that a significant amount of slack in the labour market has been removed. Based on our current project, the unemployment rate is expected to reach 6.1% by mid-2002. As a comparison, when the BoC started increasing its policy rate in 2017, the unemployment rate was 6.3% and declining.
The pace of rate hikes beyond that point will be relatively slow, about 0.25% every quarter, until the policy rate hits 1% in 2023Q1, before likely resuming the normalization process in 2023Q3. However, it is important to note that 1% would still be considered very accommodative since the BoC estimates the neutral rate is between 1.75% and 2.75%.
The amount of fiscal support during the pandemic has been a game-changer, most likely preventing a much deeper and protracted downturn, and allowing for a swifter recovery. However, this came at the expense of higher levels of government debt and deficit, which, while manageable, will require some attention.
With the economy reopening and restrictions on economic activity lifted, government support will gradually be reduced. As a result, the amount of fiscal support will be progressively withdrawn. However, for more of 2021 and early 2022, we believe fiscal policy will continue to support growth.
As the economy expands, there will be a need for fiscal policy to turn neutral in the medium term. There will be also a need to look more closely at the long term consequences of the COVID pandemic on public finances and making sure that: 1) they are on a sustainable path, especially at provincial levels, and 2) that new capacity to support the economy in the case of an adverse shock is built back.
Alberta: a more robust recovery
Alberta is set to have the strongest growth rate amongst Canadian provinces in 2021. However, it is important to note that there is more ground to gain back than elsewhere, with the economic contraction in 2020 having been more sizeable than elsewhere due to both the pandemic and a drop in oil prices. As a result, we expect the province’s economy to growth by 7.5% in 2021, higher than the 6.1% in the rest of the country. Moreover, we forecast that the Alberta economy will start to expand beyond its 2014 peak at some point in 2022, erasing the contraction seen in 2015 after almost seven years.
In addition, to stronger momentum as restrictions on economic activity are removed, the Albertan economy will benefit from a strong tailwind from higher commodity prices. As such, oil prices have increased by about 40% since the start of the year, even reaching more than $75 a barrel, based on WTI. While the spread between the WCS and WTI has widened since the beginning of the year as a result of fast normalizing production volume, the level of WCS is close to its highest since 2014. Similarly, the price of Alberta’s natural gas is also close to its highest level since 2014.
When considering both the normalization in production volume and the rise in prices, we estimate that the value of the oil production in Alberta will reach new highs in 2021. However, despite better oil revenue, we do not expect a sharp rise and rehiring in the sector. Firms remain cautious and aim to improve their balance sheets and profitability to better deal with the industry’s long-term challenges.
With the rebound in economic activity, we will also see job gains in Alberta. Similarly to the rest of Canada, the level of employment in the province will surpass its pre-pandemic level before the end of the year. We expect the unemployment rate to continue to ease and reach 6.7% by year-end and 6.2% by the end of 2022, but still above the national measure.
There is a risk that any labour shortage could be more severe in Alberta than in the rest of the country. In addition to weak immigration, the participation rate has declined more than in the rest of Canada, which means that the labour force is smaller by about 35k. Moreover, since the start of the pandemic, the province has also seen net migration out of the province, further reducing the number of workers available.
Higher commodity prices, especially energy, will support income growth in the province after a difficult 2020. This will likely mean that the province’s disposable income will increase faster than in the rest of the country, supporting consumption, tax revenues and the housing market.
The housing market is expected to remain strong in Alberta. Pent-up demand, low interest rates, higher disposable income, and changes in housing preference will continue to be the main drivers. Some cooling has been observed in recent months while the number of new listings increased, easing some of the shortages in some markets. Nevertheless, house prices in Alberta are expected to continue to grow at their fastest pace since the collapse of oil prices in 2015.
One big positive of the strong growth and higher commodity price will be on Alberta’s government finances, with oil prices well above the assumptions used in the Budget. This means that royalties from oil extraction are normalizing quicker than initially thought and will lead to a positive upgrade to the revenue forecast for FY2021-22 when updated fiscal numbers are released. Similarly, this means that the deficit is shrinking faster than previously thought. Nevertheless, this does not change the fact that a solution on both the spending and revenue sides of the deficit equation is required to ensure the province’s long-term fiscal sustainability.
The COVID pandemic remains the main downside risk to the economic outlook. As such, it is important to note that the vaccination rate of some regions of Alberta remains concerningly low. We estimate that about 25% of the population lives in areas where the vaccination rate, a least one dose the first dose, is below 60% of the the whole population. As a comparison, many health specialists suggest that a vaccination rate of at least 70% is needed to provide a minimum of herd immunity (about 35% of the Alberta’s population lives in a region where the immunization rate is above 70%). For example, the share of the population having received one dose in Grande Prairie is below 50%, making it vulnerable to the new delta variant.
There is a risk that some restrictions, at least at a local level, will need to be reinstated to slow a possible fourth wave, temporarily reducing the speed of the recovery.
 The underemployment rate includes unemployed, those out of the labout force who would like to work and those working less 50% of their normal hours.
 Wikipedia defines the base effect as: The base effect relates to inflation in the corresponding period of the previous year, if the inflation rate was too low in the corresponding period of the previous year, even a smaller rise in the Price Index will arithmetically give a high rate of inflation now. On the other hand, if the price index had risen at a high rate in the corresponding period of the previous year and recorded high inflation rate, a similar absolute increase in the price index now will show a lower inflation rate now.
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any organization or person in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication.
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