E-sight July 24: Canadians keep on spending despite inflation shock

The latest retail sales report showed the impact of high inflation, but also the willingness of Canadian consumers to keep on spending. The value of retail sales rose 2.2 per cent in May, with broad-based gains in 8-of-11 major subsectors. In other words, a strong report. 

With inflation, as measured by the Consumer Price Index (CPI), running at almost a four-decade-high of 7.7 per cent in May, it is not surprising that the value of retail sales in the month were boosted by higher prices. The value of gasoline sales stand out, as they climbed 9.2 per cent in May from April to stand 54.3 per cent above year-earlier levels. This was fully anticipated because the CPI for May showed a 12 per cent increase in the price of gasoline and the cost of filling a gas tank was up 48 per cent year-over-year. Statistics Canada noted that the impact of higher prices was also evident in a 1.9 per cent increase in the value of sales from food and beverage stores in May.  

What is more surprising is that retail sales, excluding prices, still rose 0.4 per cent in May. This isn’t booming but it is still striking because inflation at 7.7 per cent was well in excess of wage growth that averaged just 3.9 per cent year-over-year in the month. One would expect that the rapidly rising cost of living would be curtailing spending, at least in volume terms. 

It begs the question, what is keeping consumer wallets open? It might be that the sales in May were distorted by a large 3.8 per cent increase in sales at new car dealers, which followed several months of declines. This sector has had supply chain problems, so if they happened to get additional inventory for sale in May, the gain in the month might simply reflect a temporary increase caused by pent-up demand in that one sector. Another possibility is that many consumers continue to draw down on savings accumulated during the pandemic. 

Overall, the retail trade report for May was favourable, but retailers should prepare for weaker times ahead. Consumers are struggling with high inflation. That inflation has now forced the Bank of Canada to aggressively raise its benchmark overnight interest rate from a 0.25 per cent low during the early days of the pandemic to 2.50 per cent in July – and it has signalled that further interest rate increases are in store. Given the record indebtedness of Canadian households (debt-to-disposable income is an incredible 186.2 per cent), the combination of the inflation shock and the higher debt service costs is bound to eventually weigh on consumer outlays.

There are, however, some potential sources of resilience. First, labour markets are exceedingly tight. There are 890k unfilled jobs at the moment. So, any economic weakness may not lead to much labour market slack, and so long as workers have jobs, they will spend. Second, Canadians accumulated more than $350 billion in savings during the pandemic. They didn’t go to movies, restaurants, buy business clothing, spend money on transit to work, etc. The accumulated money is around a decade worth of savings. Inflation is whittling down this buffer, but the savings helps explain why wallets have stayed open during the inflation shock. 

Nevertheless, that savings cannot prevent a moderation in retail activity. The most vulnerable retail categories are those tied to interest rate sensitive segments of the economy. For example, the Canadian housing market is in the early stages of a correction. That will dampen spending on housing related items – furniture, appliances, renovations, etc. Big ticket items, like autos, might also be more vulnerable as consumers tighten their wallets and purse strings. A lot will depend on what happens in the labour market and to wages. I suspect high-skilled workers will be able to get significant wage gains, one-time payments or other compensation that will coverage a lot of the rising cost of living. Their employment is also the most secure if a downturn occurs. This will support their spending and might make luxury goods less affected than the average retailers. However, middle and lower skilled workers are likely to find that inflation continues to outstrip wage gains by a large margin. These consumers are likely to become much more price sensitive – looking for a deal or discount to save a few loonies.  So, wallets and purses may stay open, but these buyers will become more careful with their increasingly precious funds. 

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

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