E-Sight July 20: Canadian Inflation Climbs Above 8%

Canadian inflation climbed above 8% in June, but the 8.1% headline was slightly below market expectations for an 8.4% reading. Gasoline was the single greatest contributor to the acceleration, increasing 6.2% in the month and up a whopping 54.6% year-over-year. Statistics Canada reported that traveller accommodation, air transportation and food at restaurants contributed to the 5.2% year-over-year increase in services prices – all areas where there is pent-up consumer demand. However, supply distortions are also still an issue. For example, the statistical agency noted that demand for passenger vehicles continues to outstrip supply due to ongoing semi-conductor shortages. 

Excluding food and energy, core inflation came in at 5.2% in June, unchanged from May. The Bank of Canada’s three CPI special indices (trim, median, common) were 5.5%, 4.9% and 4.6% – the only change was that the bottom of the range that rose from 3.9% in the prior month. 

The single most interesting development, and perhaps why analysts underestimated the increase was a smaller-than-expected rise in shelter costs. Stats Can reported that owned accommodation expenses rose less year-over-year in June than in May, up 12.2% versus 14.8%. The reason is lower real estate commissions caused by lower home prices. Homeowner replacement cost also increased at a slower rate due to lower home prices. In other words, even before last week’s dramatic Bank of Canada rate hike, the impact of the prior tightening of monetary policy on real estate was already having an impact on inflation. In my opinion, Canadian real estate is headed for a significant correction and this will significantly dampen consumer spending. This is how the Bank of Canada will curtail domestic demand and domestic inflationary pressures. So, there is much more of this trend to come in the months ahead.

Today’s inflation report is perfectly aligned with the Bank of Canada’s messaging last week that inflation will average close to 8% in the middle quarters of this year. Look for the Bank to hike again on September 7th. I would prefer a 50 basis point increase, but they might want to deliver a bold 75 basis points to once again demonstrate their commitment to do whatever it takes to bring down inflation and re-anchor inflation expectations. A further hike on October 26th that takes the overnight rate to around 3.50% and is accompanied by the release of a Monetary Policy Report and press conference would be an ideal time to signal a pause to assess what the new restrictive stance of policy will do to the economy. Commodity prices are already starting to come down. The Federal Reserve is aggressively raising interest rates and this will temper US demand for Canadian exports. And, the Bank of Canada’s actions will curtail domestic demand, particularly Canadian real estate and consumer goods demand. This won’t address global supply dislocations, but it should take some material steam out of inflation. If it doesn’t, then the central bank will have to push rates even higher. But, the higher rates go, the greater the recession risks.

Categories: Canadian Economic Outlook, Canadian Inflation, E-Sight, Economics

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