Kevin Carmichael: Remember inflation? It’s back to haunt us

TORONTO — You remember the Consumer Price Index, right? If not, time to reacquaint yourself. The indicator is newsy again.

The CPI rose three per cent in July from a year earlier, the biggest increase since 2011, Statistics Canada reported Friday.

So forget all you’ve been reading about disinflation; prices now are at the outer limit of the Bank of Canada’s comfort zone. All things equal, the latest figures increase the odds of a rate increase before the end of the year, adding to recent evidence the economy is running hotter than anticipated.

“Maintaining stable inflation is likely to require further rate hikes by the central bank, with the next one likely coming in October,” said James Marple, an economist at Toronto-Dominion Bank.

Canada’s central bank aims to keep inflation at about two per cent, but won’t panic as long as increases stay within a range of one to three per cent.

The CPI’s surprise jump emboldened the handful of analysts who think the central bank is in danger of falling behind the curve. Brett House, deputy chief economist at Bank of Nova Scotia, said the data reinforce Scotia’s call that borrowing costs will be headed higher when policymakers next gather to set rates in September.

Ranko Berich, head analyst for Europe and Canada at Monex, the foreign-exchange provider, said the 3.1-per-cent increase in the cost of services from a year ago show Canada’s economy no longer is the feeble thing that required special care after oil prices collapsed in 2014.

“It’s looking increasingly like the BoC’s September meeting is live for a rate hike,” Berich said in an email, adding that he puts the odds of an increase at 60 per cent.

Policymakers anticipated that a series of idiosyncratic factors would cause inflation to accelerate temporarily this year, so they might shrug at StatCan’s newest tally. In its latest quarterly economic outlook, in July, the central bank says higher gasoline prices, higher minimum wages, retaliatory tariffs and a weaker currency would push inflation beyond two per cent over the second half of the year. Still, it’s unclear whether the bank was ready for a jump to three per cent.

The July Monetary Policy Report predicts CPI increases will average 2.5 per cent in the third and fourth quarters before slowing at the start of 2019. Based on that, the bank raised rates last month, and said it will continue to do so, but at a “gradual” pace.

When the Bank of Canada raised the benchmark rate, Stephen Poloz, the governor, said uncertainty over trade policy was the biggest risk facing the outlook. So the next increase will come when central bankers decide that inflationary pressures outweigh whatever damping effect the renegotiation of the North American Free Trade Agreement and the trade wars are exerting on future exports and business investment.

It will be difficult to ignore a reading of three per cent, but Poloz and his deputies on the Governing Council likely will require more evidence before accepting that prices have become untethered.

The CPI gets pushed around by volatile items such as gasoline, so the central bank relies on a few measures of core inflation that correct for that volatility. All three of those gauges were around two per cent in July for the fifth month in a row, suggesting underlying inflation is on target.

The July numbers feature an unusually large 16-per-cent increase in the cost of air transportation from the previous month, reflecting higher oil prices, increased demand and a relative lack of competition. Air Canada, the near-monopoly carrier, said when it released its second-quarter results last month that it would be charging higher fares to offset jet-fuel prices that are more than 30 per cent higher than they were this time a year ago.

“It is worth reminding investors that the BoC usually does not react to such transitory factors, which tend to dissipate,” said Sébastien Lavoie, a former Bank of Canada economist who now leads economic analysis at Laurentian Bank.

Policymakers also will want more evidence of whether Canada’s tit-for-tat trade war with the U.S. is putting upward pressure on inflation.

StatCan said it found no effect after one month of duties. Lovers of American pickles might disagree: the hamburger topping cost $3.96 in July compared with $3.85 in June. (The cost of Canadian pickles dropped to $5.53 from $5.64.) However, lean ground beef was actually cheaper, even though U.S. beef is now subject to a 10-per-cent tariff.

Relatively stable food prices show the power of competition. One of the reasons the Bank of Canada thinks inflation was so slow for so long was the price war between legacy sellers and newer entrants such as Walmart and Amazon.

However, the trade war will test retailers’ willingness to keep shielding their customers from higher costs. Eric La Flѐche, chief executive of Metro Inc., told analysts on Aug. 15 that the various retaliatory tariffs would cause some inflation; at the same time, he made clear that either Metro or its suppliers will continue to absorb some of those costs. “We will deal with it supplier by supplier, category by category,” he said. “We will be competitive.”

The outcome of Metro’s negotiations, and thousands of others like them, will play a big part in deciding the path for interest rates.

Central bankers may need more than a few weeks to determine how many companies are behaving like Air Canada, and how many are more like Metro. But they won’t need that much time. It’s pretty clear interest rates are headed higher, probably this autumn.

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