What drivers of inflation should be monitored in 2022?

By Kyle Burak, Senior Economist, Farm Credit Canada

Headline inflation continues to trend above the Bank of Canada’s target of 2%, and expectations are for inflation to remain elevated into 2022 because of pressures originating from both supply and demand factors. Pent-up consumer demand is robust due to increased household savings and low interest rates. Canadian households’ chequing and savings account balances have increased 51% and stand $158 billion higher than at the end of 2019. The Bank of Canada’s cuts to their policy rate and programs to keep credit flowing have lowered borrowing costs, placing Canadian households in a stronger position to service debt obligations.

Factory shutdowns and supply chain disruptions have reduced global inventories, while various employees’ safety measures within plants have slowed line speeds. Despite the challenges, Canadian businesses remain efficient as productivity per employee is at record levels. The reality is, with global economies re-opening and pent-up consumer demand, supply chains can’t keep up. To fill this gap, employers across all sectors are competing hard for qualified labour, resulting in higher wages and benefits.

Many Canadian food manufacturing companies are experiencing these challenges firsthand. Unfilled orders of food are at historic highs. Ramping up investments in equipment and/or vehicles is difficult given global microchip shortages and shipping disruptions. These struggles to meet demand have led to higher prices across the supply chain. We expect supply chain constraints to ease over time, but strength in consumer demand and elevated production costs should keep inflation running higher and thus higher consumer prices.

In response to the strong inflationary pressures throughout the economy, watch for the Bank of Canada to curb inflation. The Bank ended its quantitative easing program in October 2021, electing to keep its balance sheet stable and limiting money supply growth. The next step is an increase in its policy rate. Financial markets are currently expecting the rate to increase by as much as 1% (4 increases of 25 basis points) in 2022.

Food costs could get higher before they subside
Food inflation is at the top of the economic news cycle. Higher agricultural commodity prices and labor challenges are arguably the two biggest drivers.

The Western Canadian drought has caused a major decrease in grain, oilseed and pulse production of up to 30% nationally (40% in the Prairies). Challenging crop growing conditions in Western U.S. and Central Asia have also contributed to tighter supplies and higher prices. Low water levels on the Colorado River have forced water restrictions for 2022, impacting farmers in Arizona, Nevada and parts of California and Mexico. Reduced water supplies in key agriculture regions should put further pressure on imported nut, fruit and vegetable prices in the new year. Livestock prices have been trending higher than their 5-year average in 2021 as the reopening of the economy led to stronger meat demand. This turned into record-high meat prices at processing level.

Labour is a top concern throughout the food and beverage industry. At the end of the second quarter, there was over 98,000 job vacancies in food service and food manufacturing – up 34.9% and 63.2%, respectively, versus the 5-year pre-COVID average.

Food manufacturers seek to pass on cost increases from higher wages, and from commodity and energy prices, to keep their share of the food dollar. To date, many manufacturers have been fairly successful, passing on a net price increase of over 8.1% YoY through three quarters of the year. We are now seeing these higher costs make their way through the aisles, with food inflation ramping up in Q3 (Figure 1). Not all these cost increases have reached consumers, though, as companies generally attempt to periodically increase prices. If these cost pressures become long-lasting, then the pressure will grow on both the manufacturers and retailers to further elevate prices.

There are, however, a few bright spots. Reference prices for some grains and oilseeds (corn and soybeans) have come down their summer highs. Animal protein prices at the farm and processing levels have come down their highs, too. Other commodity prices (e.g., wheat) remain much higher than normal. The higher loonie also offers relief to food inflation.

Canadians rely on the supply of imported food, and the higher dollar softens the blow of higher commodity prices in some areas like fruit and vegetable products, breakfast cereals, sugar, snack foods and coffee. An increase in the exchange rate would be an advantage for domestic food companies importing inputs. Conversely, Canadian food exporters would lose some competitiveness in global markets.

We believe food inflation will remain elevated and possibly outpace the all-item headline inflation. As supply chain disruptions and labour challenges ease and the supply of agricultural commodities rebounds, we should record lower food inflation. The difficult question is around the timeline associated with a return to average inflationary pressures. Only one thing seems sure: the current economic recovery comes with heightened uncertainty. Resiliency and productivity are two qualities of the Canadian agri-food supply chain that are essential to successfully control food inflation.

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