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Economy and entrepreneurship

Supply chains, inflation and immigration: An economic snapshot with Desjardins economist Royce Mendes

April 7, 2022

Eyebrow-raising gas prices, drawn-out delivery times for big ticket items and multiplying help-wanted signs. All three symbolize top economic concerns facing Canada: inflation, supply chain disruptions and immigration.  

Desjardins economist Royce Mendes, Managing Director and Head of Macro Strategy, joined us for a conversation on these three big issues. He broke down what’s happening now and explained why they’re inextricably intertwined.

How supply snafus pushed prices higher

Energy price increases have been exacerbated by the war in Ukraine, but people should look back to the beginning of the pandemic to see where the supply chain issues, and subsequent price increases, began, Mendes said.

When people were forced to stay at home during the first wave of COVID, they started to spend a lot less money on restaurants and vacations and a lot more to replace or upgrade physical goods like electronics, appliances and furnaces, Mendes said. At the same time, rolling COVID waves around the world were shuttering production and forcing manufacturers to cut output. They expected this to be the worst recession since the Great Depression, Mendes explained, but demand roared back after two months of severe pain.

“You don’t have to have a PhD in economics to know when demand increases and supply falls, we’re going to have some major problems,” he said.

Unexpected events made supply problems worse, Mendes said, like when one of the world’s biggest container ships got stuck in the Suez Canal, blocking nearly $10 billion in trade per day for a week in March 2021.

The war in Ukraine was the next supply-chain setback as factories in both countries closed and ports and shipping lanes were blocked. Mendes now expects supply chain disruptions to persist for the rest of this year.

More jobs and higher wages are pushing prices up, too

It might be hard to remember now, but prices fell dramatically when the pandemic first hit. When prices normalized in 2021, inflation seemed higher because of that initial drop, Mendes said. Most economists expected it to level out in 2022.

Obviously, that didn’t happen. Inflation hit 5.7% in February—the highest rate since the 1990s—in large part due to the war in Ukraine. Mendes revised his forecast accordingly. But that’s not the only reason inflation is trending up.

He's seen a faster recovery than expected in the underlying economy, with more people hired and businesses operating closer to full capacity. When more people have jobs they spend more money, and businesses tend to increase wages because it’s more difficult to find workers to hire. That’s excellent news, he said, but it comes with drawbacks.

“When you add this to the inflation from these other sources, we’re left with inflation that is very clearly too high,” he said.

The Bank of Canada started raising interest rates to get inflation under control. It’s a delicate process in Canada, Mendes said, as higher interest rates affect mortgage rates. Ten per cent of the Canadian economy is in housing compared to 5 per cent in the U.S., he said, and Canadians are more indebted than Americans in part due to high housing prices.

“It means that every rate hike in Canada is that much more powerful on the Canadian economy,” he said.

He expects the Bank of Canada to raise rates up to 2.25% in this economic cycle.

Immigration could ease some of these pressures

The backlog of people waiting to immigrate to Canada ballooned during the pandemic, hitting 1.8 million applications in March, according to Immigration, Refugees and Citizenship Canada. For the next three years, the federal government plans to accept record numbers of immigrants, starting with 430,000 in 2022 and rising to about 450,000 in 2024.

On top of the positive benefits of multiculturalism, immigration will also help with the labour shortage by adding new workers to the labour market, Mendes said.

“Canada has, like many developed economies, an aging demographic. With no immigration, there are fewer and fewer people working,” he said. “That’s very difficult for the economy.”

On top of that, newcomers create new demand for housing and infrastructure. That could be a tailwind for the industry even if Bank of Canada rate hikes start to eat at the industry.

“It’s a reason to think there will still be strong fundamental demand for Canadian housing even as interest rates start to rise,” Mendes said.