This article originally appeared in Business in Vancouver on November 4, 2021.
SVP & Chief Economist, Scotiabank
The key policy question, and increasingly a key challenge for businesses and households, is to understand what is happening with inflation. From a policymaker’s perspective, the challenge is to set the appropriate policy in response to developments, while businesses must decide how to incorporate inflationary developments into their business strategies. The task for both is unusually complex owing to the multiplicity of factors affecting inflation along with uncertainty about its drivers and their persistence. Our view remains that much of what has driven inflation in recent months is temporary but is proving to be more persistent than anticipated. As a result, we have been raising our inflation forecast for a few months now as evidence accumulates that supply challenges are broader and more persistent that earlier assessed.
Why do we talk of a temporary increase in inflation? At its most basic level, this reflects an imbalance between the amount of goods wanted by firms and households and the ability of the global production system to produce those. COVID has played havoc with production chains, leading to backlogs of key production inputs, such as semiconductors and even things like shipping containers. This has created delays in the production in a broad range of goods. As COVID impacts ease and production rebounds, we expect these backlogs to clear. A key question is of course when this might happen. On that, there remains much uncertainty, and economists, including those at the Bank of Canada, have been surprised by the duration of these production challenges. We currently assess that production will catch up to demand sometime in the second quarter of 2022, though that process may be slower for certain sectors like semiconductors.
It is also clear, however, that the argument that supply bottlenecks account for the majority of the sourcing and pricing difficulties is increasingly challenged. The line between supply challenges and strong demand is becoming muddier. This is quite evident in the commodity space, where prices have in general been very robust. The economic recovery is boosting demand for a range of commodities, but weather, political developments, and shipping issues have strained the ability of producers to meet demand. At the same time, it is also very clear that rising energy costs are boosting global and Canadian inflation. Again, our current view is that the increase observed in commodity prices will partially reverse in the year to come and in so doing reduce inflationary pressures. But that is clearly a risk as commodity prices have proven to be far more resilient than expected thus far. For a country like ours, and British Columbia in particular, high commodity prices are great news, but they do come with inflationary consequences.
While there is a compelling case to argue in favour of a transitory spike in inflation for the reasons listed above, there is increasing support for the view that the strength of demand is a more important driver of recent inflation outcomes than thought earlier in the year. Some simple statistics illustrate this point. Total container traffic at the Port of Vancouver is up 10% YTD relative to 2019 levels. Ports around the world are struggling to deal with the volume of traffic. Even once containers are offloaded, there is an estimated shortage of 18,000 truck drivers in Canada according to Trucking HR Canada. That shortage is far more acute in the United States.
A further data point concerns the labour situation in Canada in general. There are currently more than 800,000 job vacancies in Canada. That’s nearly 50% more than observed pre-pandemic. In BC, that number stands at nearly 132,000, 30% more than pre-pandemic. In BC, the participation rate, which captures the number of individuals working and looking for work in relation to population, is now above where it was pre-pandemic, so these shortages are the result of demand for labour as opposed to workers dropping out of the labour force. A very tight labour market so early in a powerful economic recovery suggests wages will be on the rise. There is early evidence of this occurring in some measures of wages, but it is clear that wages will need to rise in response to the strong demand for workers. As that happens, we can expect this to add to inflation over the course of the next quarters.
Taking all these factors into consideration, we remain of the view that much of the current upward pressure on inflation will abate in the next few quarters as supply adjusts to demand. But as that happens, wages will rise in response to the strength of our economy, offsetting some of these lessened inflationary pressures. As a consequence, core measures of inflation are expected to remain at the high end of the Bank of Canada’s 1 to 3% inflation control range. That will require significantly higher short-term interest rates by the end of next year.