Inflation Update
The inflation target in Canada is a range of between 1% and 3%. People call it 2% and I won't fight much with that definition as it is the center of the range.
If I said to you that we've had an unexpected bounce back in inflation, you might look at me like I lost it... after all inflation looks like this:
Canada CPI YoY
But I believe we have.
The leading inflationary force in Canada is (drumroll please) Mortgage Interest Cost... That's right, cost of living is being most increased by the brilliant measures we use to stop the cost of living from increasing. This measure has increased so much (more than 26.4% YoY) that it now accounts for 0.7% YoY (according to statcan, my estimate was slightly lower) according to the CPI. Or more than 15% of all 'inflation'. (To the Americans laughing at our stupidity, may I refer you to OER) Luckily we seem to have started to recognize this as a society. Six months ago my frustration with the situation had me feeling like I was living in a different universe.
Yes that means interest rate hikes is the most significant inflationary force in the country by a wide margin.
Producer prices aren't part of the CPI or what's considered inflation by many but it is an interesting signpost. If producer prices are going up they're going to need to increase prices to stay in business. They were going up a lot... Last year. Since then however, PPI inflation got transitory in a big way. Prices are down over many timeframes. This doesn't immediately translate into CPI falling but it at least means that businesses don't have to keep raising prices and can flatten/reduce them. Margins can neither be too high nor too low indefinitely.
You decide for yourself, this is PPI, now +1.4% YoY
I'd call that transitory.
Wages
Wages which aren't measured in CPI, have been more rounded. They actually ticked lower in march and not simply in YoY terms. 33.12 in March (5.3%) vs 33.16 in February (5.4%). This didn't keep up with CPI last year so in some ways it's not surprising that it remained above trend. Despite this, this measure of wages is hot. Wages would need to remain flat until the fall for it to normalize.
Base Effects
Now we're approaching a strong period of inflation from last year meaning a time when base effects should be a significant help.
Last year May, June, July had, 0.6%, 1.4%, & 0.7% inflation respectively. Which means if each month comes in slightly hot this year (0.3) inflation would fall by 1.8%. at 0.2 average it would fall by 2.1%. Both of those scenarios would put it back in the target range. That's without accounting for adjustments related to Mortgage Interest Cost or Core vs Non Core inflation. We could realistically have inflation (ex-MIC) below 2% this summer without a recession.
However, if we put in another quarter like last of 1.4% inflation it's more complicated. Although the number would be 3% including a significant amount from MIC, I'd still be disappointed vs expectations from 3 months ago. We'd lap the biggest reason for optimism and as far as I'm concerned then be looking at more of a risk of inflation stickiness.
I just keep looking at inflation post May or June. After May's results, the leading measure of inflation will most likely still be Mortgage Interest Cost. Flat from here would be ~25% YoY or still ~0.6%. Yes, it's technically part of 'core'. Bank of Canada stated they expect CPI to be ~3.3% in the summer... So roughly 1/6 of which is MIC... Or roughly 2.5% inflation with rates firmly in restrictive territory. That's not 'so bad'. Is it high? Technically slightly yes. Is it sticky? Maybe. Is it a recession? No.
The problem is, that's all I've got... I was very much saying and thinking that inflation would be highly transitory. My belief was that would be largely the case whether we raised rates at 2.5% or 4.5%. The shock was going to roll off. The supply chains were going to improve. Those elements were completely predictable and the disinflation was probable. When we hit June data, if we're not THERE... The incremental small step lower will be difficult. July onwards the base effects reverse and you could see a step up in inflation.
There's enough noise in the data lag and enough slightly pent up inflation and deflation beyond that point that I honestly don't have any idea which way it goes. I don't know if it matters, but if we're going to make it matter, I don't know the solution.
I think the debate will become, "How restrictive do we need to be around 2.5-3.5% inflation?" 3.5% probably means higher for longer but what would 2.5-2.75% mean. It's within 'the range' and rates would be fairly restrictive (positive real rates). That could go either way. Lowering to 4% or even 3.5% would still be technically restrictive but might spur some acceleration which might reverse the intent. On the other hand there's the risk of sustained higher rates doing further unnecessary damage to growth.
If there's an answer, I think it will come with wages. if wages are flat or falling over the next 3-6 months I believe we'd be much closer to an easing bias. If wage growth is in the 4s it's probably more 'on plan' and if wage growth is still in the 5s there might be more concern.
Annualized Different Periods
If we annualize different stretches and examine inflation over them, I believe it's easier to see my lack of immense enthusiasm.
3 Months: 5.6%
6 Months: 3.2%
9 Months: 2.0%
1 Year: 4.3%
Now I could argue that seasonal adjustments would make the last 3 months 0.3, 0.1, 0.1 instead of 0.5, 0.4, 0.5, but I generally don't love seasonal adjustments so I won't say too much about it aside from, "there might be hope."
Food
To date, Food Inflation has been mocking me...
It may have rolled over but the lag between it and the roll over months ago has been high on my radar given my holdings in the agriculture complex taking hit after hit on pricing while "food inflation" has been a non stop talking point. Crop prices are WELL off last summer's levels yet increases in grocery stores and the CPI measure have continued further pressuring rate hike enthusiasm.
I think this part of inflation should come down but if it tracked in real-ish time, it would have already so I can't say if, when, why it hasn't. I can suggest that the margin reparation/expansion of someone in the supply chain means the situation is getting better below the surface. Things are normalizing even if it can't be seen yet.
Shelter
Shelter is a big topic & a messy one. It accounts for roughly 30% of CPI. I could (and probably will at some point) write an entire post about shelter in Canada. The problem it
1: It's not really discretionary
2: High rates slow supply (at least funding construction via pre-sales)
3: Care to guess which category the +26% YoY mortgage interest cost is part of? Even ignoring that component by itself, what does that do to rent demand... which is also a big talking point on inflation.
4: 4 new residents per housing start is problematic and demand quantity is independent of interest rates
You can obliterate the economy and destroy a lot of lives before having much impact on this problem. You can also make it worse by attempting to 'fix it' the wrong way. If you raise rates to the point where developers are bankrupt or can't develop new residences you're doing just that.
Non Core
People love to mock the exclusion of food and energy from inflation and say "CPI excluding things you actually buy" or something. I get it. I also very much believe that CPI is a bad and lagging measure. In this case however my feeling is mixed. Yes of course those are big components. However, with all commodities, sometimes prices are high enough to incentivize increased production and sometimes they're not. Food and energy prices weren't high enough to be sustainable a few years ago, now they are and that's trickling through in it's own delayed time to CPI. Gasoline crack spreads are through the roof on temporary factors, do you want central banks breaking the economy because of a strike in France? Imagine how much trouble we'd be in if that were the case.
Economic growth
One last point is that economic growth isn't inflation. Arguably it can be the solution for inflation too. the whole bad news is good news, good news is bad news is a pain. Some things matter, I'd say focus on wages, food & rent. If they moderate good news can be good news again. "Slowing down the economy," sounds gentle and all but may have effective limits given supply is also part of the economy.
Conclusion
The headline number is coming down & will likely continue to come down even if we're not in the clear. Food can come down a lot and energy, after April, may well put in negative numbers. There are some outliers and crazy factors (MIC) but most things are moving in the right direction. We likely remain stuck in the 2.5-3.5% range for at least a number of months despite how quickly we've been falling recently. Most of this decline in inflation likely didn't require rate hikes... look at every component where the solution was eventually a supply response. Despite the record and dangerous rate of increases, the damage to date hasn't been as extreme as it could have been. All of the first increase, the recent decline, and the recent resurgent impulse have been largely driven by cyclical pricing factors in global markets. It's still messy, but there's a good deal of hope.
P.S. Now real rates are above inflation, so anyone who believed that was necessary to take down inflation can also claim victory despite the fact that we moved from 8% to 4% without positive real rates taking down inflation.
P.P.S. Hearing Poloz speak about inflation is orders of magnitude more confidence inspiring about competence of central banks than... Some other former governors. Poloz 'Has a feeling' that rates may go lower next and sooner than some think. Hopefully he's right.
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