The ongoing Russian invasion of Ukraine has increased global economic uncertainty. The immediate effect of the invasion and any related sanctions has been energy price volatility, with prices of key commodities such as wheat spiking in expectation of reduced supply from both countries involved in the conflict.
The Canadian economy has posted steady growth over the past year, with GDP expanding 3.6% in 2021 alone, following steep declines related to the COVID-19 (coronavirus) pandemic in 2020. Unemployment has dropped to 5.5% in February 2022, which is roughly in line with pre-pandemic lows. However, year-over-year inflation has accelerated in recent months, rising 5.7% in February 2022 alone.
These dynamics have led to the Bank of Canada to raise its policy interest rate by a quarter point to 0.5% in early March 2022. Recent inflation readings are well above the bank’s 2.0% target, and further rate hikes are likely to occur this year.
As policy aims to cool the economy, upward pressure on global commodity prices is expected to have a mixed effect on economic activity.
Food and farming
Over the past two years, pandemic-related volatility and other incidental factors have driven commodity price swings. The FAO Food Price Index rose 20.4% year-over-year in February 2022, driven by the strong recovery in demand experienced following the pandemic downturn and related logistical challenges.
For Canadian farmers, sanctions on Russian trade and uncertainty have affected already high costs of agricultural activity. The 3 Fs—feed, fertilizer and fuel—are expected to grow more expensive due to several factors.
Wheat, a key feed grain, saw production in Canada fall 38.5% in 2021. This is largely due to drought in the Prairies region leading to a poor harvest in 2021. Global tensions are likely to keep wheat prices elevated, especially considering Russia and Ukraine together accounts for about 25.0% of global wheat exports.
A similar shock has hit already elevated fertilizer prices. Russia is a major producer and exporter of nitrogen, phosphate and potassium, which are used as crop nutrients. As the largest exporter of nitrogen and third largest exporter of both phosphate and potassium, a drop in Russian exports will contribute to a further rally in fertilize prices.
The third F—fuel—has also experienced price spikes following the invasion. While increased energy prices will have a mixed effect on the Canadian economy, it will directly raise costs for farmers.
From hog and pig farming to vegetable farming, the overall effect of the above factors are likely to remain a challenge to livestock and agricultural production. Canadian food prices rose 6.7% year-over-year in February 2022, a trend unlikely to reverse under current conditions.
Energy sector
The mixed effect of higher energy prices on the Canadian economy comes from the share of economic activity generated by oil and gas production, which contributes about 5.0% to the overall economy, further contributing 20.0% to the Alberta provincial government as well as 25.0% to the Newfoundland and Labrador provincial government.
Given Russia’s position as a major global energy producer, rising oil prices will likely generate continued strong performance for the Canadian oil and gas industry. However, this is likely to have less of an effect on economic growth than during the previous energy boom, which ended in 2014. Since then, oil companies have had fewer incentives to raise capital expenditure due to large past oil patch investments.
Oil companies are expected to reward shareholders and pay down debt with record earnings rather than make capacity expanding investments that raise employment and wages in the energy sector, contributing less to economic growth than previously experienced.
Meanwhile, rising gas prices are expected to weigh on households. In February 2022, gas prices grew 32.3% year-over-year. As a result, Canadians will have to contend with a higher cost of transportation in the near-term.
Outlook
Considerable uncertainty remains regarding the outcome of the ongoing Ukraine-Russia conflict. The extent to which sanctions and other disruptions impact the global supply of key exports such as fertilizers and crude oil will determine how much these imbalances potentially affect growth.
While the risk of further disruptions remains, the strong economic recovery over the past two years puts Canada in a good position to navigate any potential challenges in 2022.
