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If you take your eyes off Canada’s rocket car of a labour market for a moment as it zooms up the recovery road, and look back far behind it, you’ll spot something petty important that it has left in its dust.

That would be the overall economy.

And the distance between the two make a case for why Canadian inflation may quickly become more than just a supply chain story.

Last Friday’s labour force survey from Statistics Canada showed that a huge 150,000 net new jobs were created in November, adding to the already remarkable run that the labour market has enjoyed over the past several months. Employment has jumped by more than 750,000 since May.

In doing so, it has surpassed its prepandemic level by 186,000. The unemployment rate has tumbled to 6 per cent from 8.2 per cent in just six months, putting it within shouting distance of the four-decade lows that prevailed before the pandemic. The employment rate among Canadians 15 to 65 – that is, the percentage of the population with a job – was the highest on record last month.

By many measures, the labour market is fully recovered from the severe damage inflicted by the pandemic – and then some.

“For all intents and purposes, Canada appears to be at full employment and may be moving beyond,” Bank of Nova Scotia economist Derek Holt said in a research note Friday.

Yet one can’t help but wonder, when looking at the pace of the broader economic recovery, whether all this hiring is at very least premature.

Last week’s Statscan report on gross domestic product showed that, as of the end of the third quarter, GDP was still 1.4 per cent below its prepandemic level.

Statscan’s quarterly report on labour productivity, also released Friday, showed that as hiring accelerated over the third quarter, the actual output produced by those workers hasn’t kept pace. Private-sector labour productivity – defined by the amount of GDP generated per hour worked – fell 1.5 per cent quarter-over-quarter.

Perhaps this curious divergence in the recoveries of employment and output is a consequence of the federal government’s COVID-19 emergency supports – which were very much designed to maintain connections between employers and the workers sent home by the pandemic. The programs have effectively created an incentive for businesses to bring back workers and ramp up hours sooner than they might have otherwise.

The emergence of skills shortages in the reopening phase may have also motivated employers to get ahead of the hiring curve, rather than risk getting caught short-staffed as business picks up, as expected, in the coming months.

But regardless of the reasons, there are some serious implications – not least for inflation, everyone’s favourite worry at the moment.

As a consequence of employment growing faster than output, unit labour costs – workers’ wages and benefits per unit of GDP – jumped 1.9 per cent in the third quarter from the second quarter.

That’s the kind of inflationary pressure that we would normally expect to see as output approaches full capacity. It looks to be arriving ahead of schedule, delivered by the fast-closing labour gap, and despite the apparent slack in productive capacity that remains.

This does present a conundrum for the Bank of Canada, as it prepares for its next interest rate decision on Wednesday.

In its last rate decision and quarterly economic outlook in October, the central bank continued to argue that the current wave of inflation, as dramatic as it has been, isn’t the truly sustainable (and more problematic) kind that comes with an economy straining the limits of what it can produce. It pointed not only to slack in capacity – commonly called the output gap – but also at still-modest wage pressures, which it has interpreted as evidence that some slack remained in the labour market.

At the time, 12-month wage growth stood at 1.7 per cent. Two months later, that rate has jumped to 2.7 per cent. What’s more, essentially all of that wage growth has come in the past four months – signalling that wages have accelerated much faster than the year-over-year rate would suggest.

The employment figures indicate that the wage acceleration is no short-lived quirk; it’s a consequence of a labour gap that is closing fast. Even if the hiring that closed the gap was premature, it appears to be pulling forward the inflationary pressures that would normally come as the output gap itself closed.

Ultimately, it’s wage growth that serves as the critical trigger for inflation as an economy approaches full capacity. For that reason, the labour and wage numbers must take precedence over capacity measures for the Bank of Canada, as crunch time approaches for it to start raising interest rates.

If the bank is going to stay on top of the inflation wave, it’s this fast-disappearing labour gap, not the output gap, that should concern it the most.

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