Douglas Porter

March 11, 2022

The avalanche of news, rumours, and events in Ukraine and beyond continued to roll over markets this week, leaving yields higher, equities lower and oil whipsawing wildly. Amid a spike in crude oil prices on Tuesday to above $125, the prospect of dreaded stagflation became a much more common topic for conversation. On cue, the IMF warned of potentially dire consequences for the global economy from the conflict, while the ECB’s latest quarterly forecast took an axe to growth and a ladder to inflation. However, as we detail in this week’s Focus Feature, the sustainability of the oil price surge will ultimately determine the extent of the economic damage. And the fast retreat in crude in the second half of the week—back below a week ago—counsels caution on making wholesale changes on the economic outlook, at least just yet.

With that backdrop, we are indeed shaving our North American growth outlook by half a point and will gradually adjust the forecast on a step-by-step basis as the situation in Eastern Europe evolves. There are five channels through which the conflict is weighing on growth:

1. Higher inflation, mostly due to gasoline and other energy prices, but also surging commodities in general. This week brought the hefty 7.9% y/y print for U.S. CPI, the fastest in 40 years—and that was for prices mostly before the invasion of Ukraine. The spike in pump prices since then points to a higher high in next month’s report.
2. Weaker consumer and business confidence. The conflict itself, the uncertainty, volatile markets, and piping hot gas prices could all potentially skewer sentiment and cause a pullback in spending. The University of Michigan reported another big sag in consumer sentiment in March—falling to 59.7 (from 70.6 at end-2021). In perspective, that’s close to the level in October 2008, at the height of the financial crisis.
3. Supply chain disruptions may simply be aggravated, with the auto sector in particular facing yet new challenges. U.S. auto sales had already pulled back again in February (on a lack of supply, not demand), to roughly 2 million units below year-ago levels.
4. Weaker financial conditions. Amid the volatility in markets, a key point is that major equity averages remain squarely in correction terrain. The MSCI World Index is down almost 11% from the opening day of the year. A back-up in corporate credit spreads simply adds to the mix.
5. The impact of sanctions will also cut activity. Of course, the biggest impact is on Russia itself from the widespread sanctions, and we are pencilling in a 10% drop in that economy for this year. But the weaker overall activity will at least partly blow back onto other economies, and we have cut our global growth outlook by 0.7 ppts to 3.8% for this year. One counterpoint is that many countries are stepping up with fiscal support, including the EU’s proposal of a big joint bond offering to boost defence spending, as well as for other priorities.

As a result of these forces, as well as other potential known unknowns (e.g., cyber threats), we have shaved our U.S. GDP forecast for 2022 by 0.5 ppts to 3.0%. While that still looks reasonably firm, it follows the hearty 5.7% rebound last year and note that we had already been below consensus. The most recent consensus, taken in just the past week, was for growth of 3.6% this year. Clearly, in this extremely fluid environment, this could change abruptly.

It’s a very different dynamic for the Canadian economy, but we have landed in a similar spot—shaving the 2022 growth outlook by half a point to 3.5%. (Consensus is now 3.8%.) It may seem passing strange—no, strike that, it may look just weird—that the forecast is being cut in a week that Canada just released one of the strongest job reports on record for February. In the month, employment surged 336,600, chopping the unemployment rate to the second lowest level in the past 50 years (at 5.5%), even as the participation rate jumped back up to normal. And, this was before some provinces had fully re-opened, pointing to potentially further solid gains in coming months.

On top of the blow-out jobs results, there is also the small matter that the Canadian economy should prove relatively resilient versus others in this soaring commodity price world. One way to quantify those benefits: Net external trade in resource goods is now about 6% of GDP, and the Bank of Canada’s commodity price index is now up more than 50% y/y (and is closing in on the 2008 record high). This implies a net boost to the economy of about 2%-to-3% of GDP from the commodity price surge. Because of the lack of a response of the loonie to this surge—even the blow-out jobs data barely budged the currency—a wide variety of resource prices have hit record highs in Canadian dollar terms. Most notably, WTI hit an all-time high in its C$ equivalent on Tuesday at almost C$160/barrel.

Yet despite all of this, we believe the downside risks from the five factors above offset the positives, with consumers facing the full force of the rise in energy prices. Moreover, the Canadian economy is infamous for not necessarily translating strong job gains into strong GDP gains, owing to a lacklustre productivity performance. The fact that the vast majority of the job growth in February was in lower wage sectors, such as hospitality and retail trade, reinforces the point.

All eyes will be on the Fed next week, and its widely expected first rate hike on Wednesday. But that very day will also have the big economic release from Canada, with the February CPI due. While Canada faces somewhat less intense inflation forces than the U.S., and arguably even Europe, it’s not far behind. We look for headline inflation to accelerate to 5.5%, a 30-year high, albeit a hefty 2.4 ppts below the U.S. pace. And this will not capture the latest run in energy prices, which threatens to push headline inflation above 6% in coming months. Of course, that previously unimaginable pace is a pittance next to possible double-digit prints in some other economies in the weeks ahead.

Today marks the two-year anniversary of the official declaration of the pandemic, a day of infamy to be sure. In some ways it is entirely appropriate that on this very day that the Canadian economy would get its revenge with a complete recovery reported for the jobs market. Amid the vast array of wildly impressive results from the February employment report—and it received the highest grade we have ever given for a jobs result at 98.7—perhaps the most impressive was total hours worked. Not only did they more than reverse January’s sag with a 3.6% surge, but they are now at an all-time high. And in stark contrast to the Great Resignation in the U.S., both the employment rate and the participation rate are basically back to pre-pandemic levels. So, at the very least, amid all the traumatic news from Ukraine, let’s be thankful after two challenging years of the pandemic that the jobs market has managed to restore some sense of normalcy.

Doug Porter is chief economist and managing director, BMO Financial Group. His weekly Talking Points memo is published by Policy Online with permission from BMO.