Business prof predicts surge in bankruptcies as soaring inflation spurs rate hikes

toronto financial district

A prominent Ottawa business expert is predicting a wave of bankruptcies in the coming months as surging prices at gas pumps and grocery stores prompt Canada’s central bank to further raise its benchmark interest rate in a bid to put the brakes on inflation.

Ian Lee, an associate professor at Carleton University’s Sprott School of Business, expects the Bank of Canada to impose “multiple” interest rate hikes this year as it tries to rein in an annual inflation rate that climbed to 5.7 per cent in February, its highest level since August 1991.

Ottawa’s inflation rate was 6.3 per cent, up from 5.9 per cent in January and the third-highest in the country after Charlottetown and Calgary.

Economists are warning that the inflation rate could yet go higher on the back of rising prices as Russia's invasion of Ukraine pushes up global oil and wheat prices. 

Two weeks ago, the Bank of Canada raised its key policy rate to 0.5 per cent, marking the first hike in two years, and warned of more hikes to come to rein in inflation.

That in turn will jack up the cost of borrowing for countless small businesses that rely on revolving lines of credit to help fund their day-to-day operating expenses, Lee explained. Those extra costs will likely push many mom-and-pop operations that were already barely treading water during the pandemic over the edge, he added.

“Anybody who thinks we’re going back to the … days before COVID arrived in March 2020 and happy days are here again are sadly going to be mistaken,” Lee said.

Looming interest rate hikes could be the final blow to a host of bars, restaurants, retailers and small service-oriented businesses such as barbershops, he said – especially those in the downtown core that saw their customer bases evaporate overnight after employees abandoned offices in droves early in the pandemic in favour of working from home.

“Business is Darwinian,” Lee said, adding he expects to see a “significant increase” in business failures as 2022 rolls on. 

"Business is Darwinian. The weaker companies die. Strong firms will survive."

“The weaker companies die. Strong firms will survive. But I expect to see bankruptcies increase in the downtown ecosystem.”

Lee, who was a mortgage manager when the Bank of Canada raised interest rates to more than 20 per cent in the early 1980s to combat soaring inflation, said he doesn’t expect rates to return to those levels. But he says the key rate is almost certain to hit at least two per cent by the end of the year as the central bank tries to nip the latest inflation surge in the bud.

“When the genie gets out of the bottle … you’ve got to put it back in the bottle,” Lee said. “And there’s only one way to put it back in the bottle. That’s called interest rate increases.”

While various levels of government are doling out grants to help hard-hit downtown businesses weather the storm, the former banker said the funds will do nothing to help less competitive retailers and restaurants that are already teetering on the brink survive over the long haul. 

“All it’s going to do is postpone the inevitable and waste scarce resources on companies … that are hanging on by their fingernails,” he said. “This will merely allow them to hang on by their fingernails for another (few) months and they’ll still fail.”

Tu Nguyen, an economist with accounting firm RSM Canada, said inflation is expected to be closer to six per cent in March and could even reach seven per cent for the first time since the early 1980s.

“Just be ready for inflation this year to stay high,” she said. “It's going to be difficult.”

Helping to drive the increase in February were higher gasoline prices, up 32.3 per cent compared with February 2021 and up 6.9 per cent from January. The annual inflation rate excluding gas prices would have been 4.7 per cent in February.

Grocery store prices were up 7.4 per cent for the largest yearly increase since May 2009, pushed higher by rising fuel costs that are being passed on to shoppers.

Shelter costs, which include prices for homes and rental units, rose at their fastest pace since August 1983. BMO chief economist Douglas Porter said the 4.2 per cent year-over-year increase for rents was a byproduct of the raging housing market where prices continue to rise.

Although groceries and gasoline grabbed headlines, RBC economist Rannella Billy-Ochieng noted that prices for two-thirds of the basket of goods used to calculate inflation rose faster than the central bank's two per cent target in February.

The 5.7 per cent reading for inflation follows the jobs report last week by Statistics Canada that found average hourly wages in February rose 3.1 per cent compared with one year earlier.

“If it feels like everything is getting more expensive, it's because it is,” said Royce Mendes, managing director and head of macro strategy at Desjardins.

Prices for some of the key drivers of inflation in February are likely to go higher this month, especially for gasoline as global oil prices have risen in line with uncertainty around Russia's unprovoked invasion of Ukraine. Gasoline prices on Tuesday were 11 per cent higher than at the end of February, Mendes said.

Two weeks ago, the Bank of Canada raised its key policy rate and warned of more hikes to come to rein in inflation and bring it back to the central bank's target zone of between one and three per cent. Including last month, inflation has spent 11 consecutive months above that zone.

The average of the three measures for core inflation, which are considered better gauges of underlying price pressures and closely tracked by the Bank of Canada, was 3.5 per cent for February, pointing to more pervasive and broad-based pressure on prices that has left the central bank uneasy about inflation.

The February average was the highest rate recorded since June 1991.

Even if the global drivers of inflation start to cool, domestic pressures may ramp up in their place. Mendes said further easing of public health restrictions could see increases in prices for services.

“Even as the headline inflation rate is likely to decelerate, beginning in the second quarter and over the course of the year, it's likely the Bank of Canada will continue increasing interest rates to fight off those underlying, homegrown inflationary pressures,” he said.

Pressure is building on the federal Liberal government to not add fuel to the inflationary fire with its budget expected in the coming weeks. On Thursday, the Conservatives called on the government to chart a path to balance the budget, while NDP Leader Jagmeet Singh used an event in Brampton to call for a tax on corporate profits.

– With additional reporting from the Canadian Press