May 2022 Quarterly Economic Commentary with CIBC

With the support of our Builder Member financial institutions, the OG100 Quarterly Economic Commentary takes an in-depth look at recent economic conditions with a lens specific to helping Ontario’s mid-sized companies make better-informed business decisions.

May 2022 with Builder Member CIBC

Author: Andrew Grantham, Executive Director and Senior Economist | Economics | Capital Markets


Like most areas of the country, the Ontario economy has enjoyed a much faster recovery from 2020’s pandemic-driven downturn than it has from previous, more traditional, recessions. However, the recovery hasn’t been quite as quick as some other parts of the country, most notably BC and Quebec. Can Canada’s largest provincial economy close the gap, or has the pandemic seen a lasting shift in the economic landscape?

That’s going to come down to the balance in a tug of war between positives and negatives. There are indeed some positives for Ontario that are not shared across all other provinces, but the local economy is also more suspectable to some of the biggest risks we face today, namely high inflation and rising interest rates.

A mid-race stumble

Looking back on last year’s performance, it’s clear that Ontario’s economy has been held back more than others by supply chain disruptions, and in particular, their impact on the auto sector. Having closely matched the performance of neighbouring Quebec in the first year of the recovery, Ontario lagged behind in the second half of last year as those disruptions impacted production and export volumes.

The flip side of the coin, though, is that as these disruptions ease, the Ontario economy should be able to grow somewhat faster than other areas of the country and close that gap (Chart 1). The difficulty is knowing exactly when that will occur, particularly with the war in Ukraine and lockdown measures in China adding a new layer of uncertainty to progress in supply chains.

Russia’s increasing isolation on the global stage could also cause near-term problems for manufacturing firms in the province. Despite Russia directly accounting for only 0.1% of total Canadian imports, almost 1% of what we import initially originates in Russia.

Nickel, palladium and other commodities from that country are particularly important in manufacturing supply chains, including autos. Longer-term, though, there are also ways for Ontario to help fill gaps left by Russia in the global supply of commodities, and the provincial government has committed funds to help the exploration and development of mining operations in the north of the province.

Chart 1 – Ontario to catch up with Quebec as supply disruptions ease
Source: Ontario and Quebec finance, CIBC
A fiscal bump

The provincial government will also have a direct impact on growth within the economy this year, through an acceleration in its own spending. While most provinces are seeing their spending slow, or even decline, as Covid-related expenses ease, the Progressive Conservative’s pre-election budget served up a 6.3% increase for fiscal 2022/23. That included a 10% rise in base program spending, which is basically everything not directly linked to the ongoing pandemic.

Education, health and investments to improve internet connectivity were the main areas to see spending increases, while there was also a greater than normal provision made for as yet unallocated expenditures. The end result will have government spending maintaining the huge gap that has opened up relative to what was planned prior to the pandemic (Chart 2).

With the province also temporarily cutting fuel tax and announcing some other measures to help households with the cost of living, government policy will at least temporarily be a bigger boost to the Ontario economy than what we’re seeing from fiscal authorities in other jurisdictions.

Chart 2 – Ontario government maintaining higher spending relative to pre-pandemic plan
Source: Ontario Finance, CIBC
The twin risks

The two big concerns for the economic outlook at present, whether it be for Ontario or any other province in Canada, is how resilient growth will be given the headwinds of rapid inflation and rising interest rates.

Ontario consumers might be a bit better placed to cope with the squeeze on purchasing power coming from higher inflation. Relative to the rest of the country, the province’s households typically spend a slightly lower than average proportion of their income on food and energy – two areas of non-discretionary spending that have seen rapid price appreciation in recent months.

Savings built up during the pandemic, which were previously expected to drive a rapid acceleration in services spending, may now be used as a cushion against rising inflationary pressures. The province doesn’t particularly stand out on that score. Bank deposit data show Ontarians increased their savings less than households in BC and Quebec, but more than those in Alberta and Saskatchewan, during the pandemic (Chart 3).

Chart 3 – Ontario in line with national average in terms of excess savings
Source: Haver, CIBC

But the challenge for Ontarians will come from the central bank’s response to above-target inflation, as it pushes up interest rates, as Ontario’s homeowners are particularly exposed to the higher mortgage debt levels they built up as they chased rising house prices. Nationally, if the Bank of Canada raised interest rates up to the mid-point of its estimate for the neutral rate (2.5%), households’ debt service costs would return to peaks seen in prior cycles.

These are peaks that have corresponded not just to a slowing in the housing market, but a modest rise in insolvencies and softness in overall consumer spending. If interest rates were to rise above this level, as financial markets currently expect, then these debt service costs would rise to unprecedented levels (Chart 4).

Chart 4 – Debt service costs would reach unprecedented levels if BoC hikes beyond 2.5%
Source: Statistics Canada, CIBC

For households in Ontario, the pain would be amplified by the fact that, even before increasing, interest payments on debt soaked up a greater share of disposable income than elsewhere in the country (Chart 5). The latest monthly housing data have shown that, after an early-year surge as buyers looked to take advantage of interest rates locked in before the Bank of Canada started hiking in March, prices are edging lower and activity appears to be sharply decelerating in resale markets.

Chart 5 – Ontario households already paid more than others to service debt, before interest rates started to rise
Source: Statistics Canada, CIBC

The silver lining stemming from households’ sensitivity to higher interest rates is that it puts a cap on just how much higher borrowing costs need to rise in order to slow inflation back to its 2% target. Because of that, our forecast is that interest rates will rise to 2.5% by early 2023, not as high as financial markets are currently expecting. That would see longer-term interest rates, including term borrowing for corporates and fixed rate mortgages, ease a bit from current levels in the second half of this year.

Decelerating, but closing the gap

Like other provinces, economic growth in Ontario is likely to decelerate beyond 2022 as tighter monetary policy takes aim at inflation. But on a relative basis, through 2023, Ontario should be able to close the gap between it and some of the provinces that have thus far seen a faster recovery, helped by an easier provincial fiscal stance, and an easing in supply chain disruptions in manufacturing.

Higher interest rates will have a bigger impact on Ontario’s more indebted households than those elsewhere in the country. However, as long as that hurdle isn’t set too high by the Bank of Canada, consumer spending growth as well as the rebound in manufacturing production should support a continued, if decelerating, economic expansion.

Watch for the next edition in Q3 2022 with Builder Member RBC