Surging commodities driving Canadian economy as storm clouds gather

25 May 2022 3 min. read
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Surging commodity prices – including oil and gas, food crops, and metals – are helping drive Canadian economic growth, but central bank responses to rampant inflation are likely to cool an overheated economy, according to RSM Canada’s most recent quarterly “Real Economy” report.

The Bank of Canada earlier raised its interest rate by half a percent to 1%, and economists at RSM expect a further rate hike next month – with a 50 basis-point increase not out of the question.

The central bank is responding to two broad factors with rate hikes. First, the war in Ukraine and Covid lockdowns in China are further pressuring supply chains and driving inflation outlook higher. Second, the Canadian economy is overheated and increased borrowing costs would dampen consumer spending and investment in the housing bubble – tempering inflation while consequently putting the brakes on economic growth.

With global financial conditions deteriorating and global economists projecting slowed growth or recession, Canada will be hit as well. The RSM report notes that financial conditions in the country are below normal and a drag on the economy is likely in the coming quarters as the tendency to borrow or lend declines.

RSM Canada financial conditions index, excluding commodities

Despite the expected rate hikes, inflation will remain at 6% in the coming months before the central bank’s policy changes are felt.

Canada’s commodity heaven

The war in Ukraine means that a large amount of commodities, including oil and gas, wheat, corn, and barley have been taken off the market. Russia and Ukraine together account for a quarter of global exports of wheat, a fifth of corn, and 30% of barley.

Russian and Ukrainian exports have been drastically curtailed by the conflict, and there are indications that Russia has been destroying Ukrainian farmland and agricultural equipment to provoke a global food crisis and place pressure on Ukraine’s Western allies.

The bulk of Russia and Ukraine’s food exports go to developing countries, raising the prospect of starvation and social instability in addition to high prices. Food shortages have the potential to cause social unrest and mass migration in North Africa and the Middle East, as they did previously in the leadup and aftermath of the Arab Spring.

Agricultural commodity prices

Canadian commodity producers are benefitting from the surging prices caused by the unfolding human tragedy in Eastern Europe. Canada and the US produce many of the same commodities as Russia and Ukraine, and will be motivated to ramp up production to capitalize on global shortfalls.

However, increasing production faces the stiff obstacles of inflated energy and labor costs.

Consumers will inevitably pay more for staples regardless of North American production increases, with food inflation pegged to continue soaring above last year’s elevated levels.

"Russia's invasion of Ukraine has destabilized global food markets by disrupting production and trade flows, putting Canada – as well as the United States – in a position to replace some of the agricultural products currently in short supply,” said Tu Nguyen, economist and ESG director with RSM Canada. “North American businesses that produce agricultural commodities will need to look ahead and prepare accordingly, whether by increasing production or securing future contracts, as global food supplies are disrupted into next year."