- No major changes to the outlook for Canada and the United States. Exceptionally strong recovery still expected this year and next.
- Supply challenges are temporarily pushing inflation above central bank targets and are increasingly difficult for firms to manage. We think supply will gradually rise to meet demand as the summer progresses, but it may be possible that shortages of goods and materials act as a brake on growth in the interim.
- Our rate calls remain unchanged: The Bank of Canada is forecast to raise its policy rate in 2022-Q3, and the Federal Reserve will likely begin tapering in January 2022 before raising interest rates in 2023-Q2.
There are no material changes to our US and Canada outlook this month. Economic indicators continue to suggest a strong rebound is underway, though Canadian data are muddied by the impact of COVID restrictions in April and May. In the Canadian context, solid progress on the vaccination front and sharp reductions in new infections have led many provinces to announce gradual re-opening plans which suggest that much of the economy will be re-opened by the end of the summer. This should allow a forceful rebound in the sectors that continue to be deeply affected by COVID. This is all contingent, of course, on continued progress in the fight against the virus.
There are three big uncertainties facing the forecast for Canada and the US. How temporary will the current overshoot of inflation be? Associated with that question, will supply rebound fast enough to facilitate the growth in demand we anticipate? Finally, how quickly will labour markets improve?
On inflation, the most recent inflation readings in Canada and the US clearly point to an acceleration in inflation that exceeds inflation targets. We view these exceptional pricing pressures as temporary, as do the Bank of Canada and the Federal Reserve, but believe inflation will slow yet remain sustainably above targets once these impacts pass and output gaps move into excess demand (expected at the end of this year in Canada). In the meantime, shortages of inputs and the consequent increase in their prices are leading to a rapid adjustment in consumer prices. In the US, these price pressures are exacerbated by a high number of job vacancies that are putting upward pressure on wages.
There is not yet compelling evidence that supply challenges are abating. In Canada, for example, the economy-wide inventory-to-sales ratio is at the lowest level since 2014. In relation to sales, retail inventories are at their lowest level ever. In the US, a record share of firms are indicating that backlogs of orders are rising and that customer inventories are too low. And of course, commodity prices continue to suggest that demand exceeds supply in some sectors. We remain comfortable with our view that supply will increase enough to attenuate the temporary and substantial overshoot of inflation targets, but this appears to be a riskier call the more data we get.
In Canada, labour markets remain deeply affected by the pandemic and associated mobility restrictions. In May, employment was 3% below pre-pandemic levels, as the third wave resulted in a deterioration from the March result, which had pointed to employment being only 1.5% below pre-pandemic levels. The weakness in employment is concentrated in certain industries and types of workers, but we anticipate that employment will rebound strongly in months to come as mobility restrictions are lifted. That is certainly the pattern observed in the previous waves. In the US, nonfarm employment remains stuck at about 5% below pre-pandemic levels despite a record rate of job openings.
There remains a sharp divergence between employment and inflation outcomes in Canada and the US, complicating the task of the Bank of Canada and the Fed. This is particularly so in the US considering the relative underperformance of employment. In view of our growth outlook, we anticipate that labour market outcomes will improve substantially as the year progresses, even as wage growth picks up. Given that, and our forecast that core measures of Canadian inflation will be sustainably at 2% by the third quarter of this year, we still expect the Bank of Canada will raise interest rates in 2022-Q3. The Federal Reserve is forecast to raise interest rates in 2023-Q2 given the lagged employment recovery relative to Canada, but we expect it will begin tapering asset purchases next January. At this point, the upside surprise to inflation suggests that risks to the rate calls appear skewed to the upside, both in terms of timing of the initial move but also the speed at which rates will rise when they do move.
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