What's killed Canada's inflation?
Posted on 02-11-2014 03:02
Summary: What killed inflation?
What killed inflation?
It’s the great conundrum of the past year. Canada’s annual rate of inflation has sat below the 1.5-per-cent mark for 18 months in a row, the longest such stretch since the late 1990s. Month after month, it’s confounded forecasts and is now running at 1.2 per cent.
And though we may have hit a trough in inflation, most economists don’t expect it to come roaring back any time soon.
Some of the forces dampening inflation are clear. There’s still some slack in the economy, while the entry of U.S. companies such as Target Corp. and ferocious competition in the retail sector have put pressure on prices.
But the answer to the inflation mystery goes beyond the retail sector, with researchers citing a blend of temporary factors and deeper shifts in the economy.
“It’s a real head-scratcher,” says Philip Cross, fellow at the Macdonald-Laurier Institute and former chief economic analyst at Statistics Canada.
Mr. Cross also said we may now be in an era where technological change, coupled with China’s integration into the global economy have become “long-term forces keeping prices down.”
Those forces have several implications. A low-inflation outlook means the Bank of Canada is in no rush to raise interest rates – most analysts don’t see any hike until next year. That’s good news for consumers grappling with high debt loads and earning only modest wage gains in recent years. But it could leave the Canadian dollar vulnerable to further declines.
For now, stubbornly low inflation is a “puzzle,” not only in Canada but through the developed world, said Erwin Diewert, professor at the University of British Columbia’s Vancouver School of Economics who spent four decades scrutinizing trends in inflation.
Even the Bank of Canada, in last month’s monetary report, noted that while its analysis has improved, it still has an “ incomplete” understanding of the inflation picture. It figures retail competition will this year knock about 0.3 percentage points from core inflation (a less volatile measure closely tracked by the central bank, which strips out some food and energy prices). But the so-called Target effect “does not explain all of the weakness in inflation.”
For last year as a whole, the annual average inflation rate was 0.9 per cent, the third-lowest rate in two decades. Food and transportation inflation subsided. Mortgage interest costs were also lower, with four years in a row of declines. In December, prices for pasta, household appliances, men’s clothing, prescribed medicine and travel tours were all lower than a year earlier.
Canada is not alone. Inflation has been drifting lower in many advanced countries, reflecting decelerating food and energy prices along with still-elevated unemployment rates.
Some clues stem from temporary factors. For example, some of the most widely prescribed drugs in Canada, such as Lipitor, came off patent in 2012, and consumers can now opt for cheaper generic options, TD economists note. Grocery wars chopped food inflation to 1.2 per cent, half the pace of a year earlier. And in British Columbia, prices were actually lower in 2013 than a year earlier after sales-tax changes.
Broader changes are at play too. Outsourcing and technological change has reduced demand for labour and put downward pressure on wages. Internet shopping – and the ability to compare prices online – is another factor, says Prof. Diewert.
Statistical noise in the data may also be a factor, noted CIBC deputy chief economist Benjamin Tal in a report last month.
But the era of moribund inflation may be coming to an end. The weaker Canadian dollar will eventually put upward pressure on prices as import costs rise. The quickest prices to respond will likely be gasoline, natural gas and home heating, said Mr. Cross. Industries with heavy reliance on energy, such as airlines and trucking, will be faster to raise prices. So will sectors with little inventory, such as travel services, while there may be a lagged result among firms with a lot of inventory.
That said, research shows exchange rates aren’t the biggest influence on consumer prices. “We’ll see a slight upward push on the overall CPI from this, but the big story over the next year is a continuation of the very low rates of inflation that we’ve seen for five or six years now,” he said.
The economy is too weak to support a big increase in prices, he said. With tighter household budgets, if consumers find they’re spending too much at the pump, they’ll cut back on other expenses.
Until overall employment and wages start to pick up, “you’re not going to see consumers increasing spending across the board, which is what you’d need to see for some increase in inflation.”