U.S. inflation just topped 5 per cent. Is Canadian inflation next?

Article content

The most hotly anticipated inflation numbers in years are set to arrive on July 28, as watchers of the economy are eager for a clearer read on whether the extreme price pressures that have beset the United States this spring are spilling into Canada.

Article content

Last week, the U.S. government released June figures for its Consumer Price Index (CPI) and the data showed that inflation shot up 5.4 per cent from a year ago — the steepest climb since the Great Recession. The eye-watering number stoked concerns that Canadian inflation could go the way of the U.S. since it has tracked higher than the Bank of Canada’s target range of between one and three per cent for two consecutive months.

The central bank’s governor, Tiff Macklem, has said repeatedly this spring that he thinks the current burst of inflation will pass, as the faster pace of price increases is being exaggerated by comparisons to the CPI’s collapse a year ago during the heart of the COVID-19 recession. The Bank of Canada said last week in a new economic outlook that the economy continues to struggle with the aftereffects of the pandemic, and that “slack” in demand will eventually offset a temporary spike in inflation.

Article content

Still, price dynamics clearly have the central bank’s attention.

“Of course there’s some uncertainty here, we don’t have a crystal ball,” Macklem told reporters after the July 14 release of the Monetary Policy Report. “We will be watching the evolution of inflation very carefully.”

The CPI has been climbing steadily higher all year, jumping to a year-over-year increase of 3.6 per cent in May, the fastest since May 2011. Still, the number isn’t yet a concern for Macklem, who expects the CPI to track above the target range for the next few quarters. Policy-makers last week reiterated that they intend to leave the benchmark interest rate at 0.25 per cent until at least the second half of next year, even though the central bank’s forecast shows the stimulus will keep inflation above the Bank of Canada’s two-per-cent target until at least the end of 2023.

Article content

Research by Toronto-Dominion Bank economist Sri Thanabalasingam suggests Macklem was right to keep his nerve in the face of the startling CPI reading coming out of the United States. Thanabalasingam argued that there are several reasons to suspect that Canadian inflation will not mimic the situation south of the border.

“Inflation has been the topic du jour in recent months,” Thanabalasingam wrote in a July 13 note. “Price pressures will certainly rise in the north as restrictions are lifted but reaching U.S. levels is unlikely.”

Part of the reason costs of goods and services are rising at a faster rate in the U.S. than in Canada is due to their respective timelines of reopening, Thanabalasingam wrote. When provinces were tightening health measures in December to quell the second wave of COVID-19 infections, various U.S. states were reopening, allowing for a more rapid recovery. As evidence, Thanabalasingam cited recreation costs, which rose 1.5 per cent since December in the U.S. but dipped 2.2 per cent in Canada.

Article content

As well, consumers are facing tighter supply constraints south of the border, with bottlenecks and a semiconductor shortage driving up prices. That was especially true in the used vehicle market, which saw 18-per-cent price growth since the beginning of the year and accounted for a third of the inflation growth in May.

“Vehicle prices have also risen in Canada, but not nearly to the same extent as the U.S., due in part to ongoing health restrictions holding back consumer demand,” Thanabalasingam wrote.

Article content

As provinces open up, Thanabalasingam expects inflation to track above the Bank of Canada’ target range for a while, which will cause the gap between Canadian and U.S. CPI readings to narrow. But Canadian inflation increases might stop short of the American numbers. Labour shortages in Canada aren’t as extreme, which should restrain demands for higher wages. A stronger Canadian dollar will also act as a disinflationary force by making imports cheaper.

“Although the Canadian dollar has depreciated a bit recently, we expect this to turn around as investor risk appetite bounces back and growth expectations firm,” Thanabalasingam said. “Over a longer horizon, as transitory impacts fade, we expect inflation in both countries to moderate and to fully converge.”

Financial Post

• Email: [email protected] | Twitter: biancabharti

_____________________________________________________________

 If you liked this story, sign up for more in the FP Economy newsletter.

_____________________________________________________________