The Canadian economy grew at an annual rate of 6.7 per cent in the fourth quarter, much faster than the Bank of Canada was expecting, guaranteeing an interest-rate increase when policy-makers announce the results of their latest policy deliberations on March 2.

A war in Europe has upended the near-term outlook, which was dominated entirely by inflation until the middle of last week, when Russian President Vladimir Putin stunned the world by sending a wave of troops into Ukraine. Inflation remains too high for the Bank of Canada to ignore, especially with evidence of strong demand.

“Canada’s economic engine was going almost full throttle,” Arlene Kish, director of Canadian economics at S&P Global Inc., said in a note to clients.

Kish predicted a quarter-point increase, a “first step in slowing demand as supply catches up,” she said. “Geopolitical events are impacting energy prices, adding to already strong inflationary pressures, and may require the Bank of Canada to act more swiftly during the initial monetary policy tightening cycle.”

Business investment, fees related to home sales and company stockpiling led the surge in economic growth in the fourth quarter, Statistics Canada said. The latter could help offset inflation pressures, since it suggests companies were either learning how to deal with all the supply disruptions that came with the pandemic, or had decided to build their inventories in anticipation of new ones.

“The inventory component of GDP was generally a much larger boost to (fourth-quarter) growth than we had penciled in, similar to end-of-2021 GDP data in the U.S.,” Veronica Clark, an economist at Citigroup Global Markets Inc., said in a note. “This could partly be due to continued global supply issues, as inventories of intermediate goods are accumulated while final production is stalled due to shortages of some final inputs.”

A separate Statistics Canada report showed that GDP, based on output by industries, was little changed in December, suggesting the economy held up in the face of the Omicron wave of COVID-19 infections. The agency said preliminary information suggests GDP increased 0.2 per cent in January, a positive surprise, because there had been speculation that strict health restrictions in Ontario and Quebec might have caused economic growth to stall at the beginning of the year.

“These reports clear the way for the Bank of Canada to begin its hiking process,” Phil Suttle, a former Bank of England and New York Fed economist who now runs his own research firm, Suttle Economics, said in a note to his clients.

The Bank of Canada in January predicted Canada’s gross domestic product would  grow at an annual rate of 5.8 per cent in the fourth quarter, a strong enough estimate for the central bank to conclude the time had come to end its promise to keep the benchmark interest rate near zero until at least the spring of 2022.

Canada’s economy ended 2021 with considerable momentum, as the fourth-quarter acceleration followed growth at an annual rate of 5.5 per cent in the third quarter, which was also much faster than the country’s economy typically expands.

Overall, GDP grew 4.3 per cent in 2021, enough to get back to $2.13 trillion, slightly more than at the end of 2019. The eight-quarter recovery was a bit faster than the average 8.75 quarters it took GDP to recover during Canada’s five recessions since 1974, according to Jocelyn Paquet, an economist at National Bank Financial.

Household spending led the most recent recovery, as Canadians took advantage of elevated savings and low interest rates to buy houses. New construction, resales and renovations were at record levels. Mortgage debt climbed 10.3 per cent in 2021, an unprecedented increase of $182.4 billion, Statistics Canada said.

That consumption impulse could begin to fade, as household disposable income dropped 1.3 per cent in the fourth quarter from the previous quarter, even as employee compensation increased 1.9 per cent.

The main reason was the federal government’s tapering of emergency benefits, as government transfers to people dropped almost 12 per cent in the final three months of 2021. Transfers were about 19 per cent of all disposable income, marking a return to pre-pandemic levels of less than 20 per cent, Statistics Canada said.

The savings rate dropped to 6.4 per cent from nine per cent, still high by recent historical standards, but down from the previous five quarters, when the savings rate was above 10 per cent.

Prices for financial assets tied to short-term interest rates suggest traders’ confidence that the Bank of Canada will raise interest rates is fading, as worries that the financial and economic sanctions the West is using to hobble Putin’s ability to fight a war could lead to a global recession or financial instability.

Inflation is probably the greater threat to Canada, at least for now. The consumer price index surged to 5.1 per cent in January from a year earlier, the biggest increase since the central bank started targeting inflation in 1991.

Even if much of that inflation is related to supply issues, and, therefore, beyond the Bank of Canada’s control, the latest GDP numbers show there is also a demand element. Commodity prices are surging anew because of the war, and that will strengthen demand in Canada because the country exports much of what Russia and Ukraine export.

The Bank of Canada’s target for year-over-year increases in the CPI is two per cent. Some economists observed inflation might also now be hurting growth, as weaker consumption could be the result of higher prices.

“This morning’s GDP reports underline the risks from waiting,” economists at RBC Capital Markets said in a report.  “From a fundamental perspective, there is no real justification for the BoC to avoid raising rates due to developments in Russia.”

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