A rising dollar, soft labour costs and energy prices are holding back inflation but it could hit Bank of Canada's target in 2018
TORONTO, July 13, 2017 /CNW/ - Headwinds, such as recent gains in the Canadian dollar, soft labour costs and lower energy prices, have kept inflation tame, but in the medium term, Canada's consumer price index (CPI) will push toward the Bank of Canada's target, finds a new report by CIBC Capital Markets.
The report, Canadian Inflation: What's Gone Wrong? co-authored by CIBC Chief Economist Avery Shenfeld and Senior Economist Nick Exarhos, also examines the impact of certain inflation drivers, including the regional housing boom, on the overall CPI measure.
"For each of the issues we looked at, the impacts are in the range of a decimal place or two on the CPI. But when added together, they're material enough to push CPI inflation above the 2 per cent target by next spring," says Mr. Shenfeld.
"That won't be alarming to the Bank of Canada, given how long inflation has run below target. But it might add a dose of pressure to long-term rates and breakeven inflation assumptions in the real return bond market, given how dovish current market expectations are for Canada's CPI," he says.
Mr. Shenfeld noted that the Bank of Canada's July 12 rate hike – its first in seven years – is resulting in a temporary drag on inflation.
"By pushing the Canadian dollar stronger, the Bank of Canada's rate hike may have delayed achieving its 2 per cent inflation target. But not for long," he says. "A likely reversion in productivity to trend would, along with minimum wage gains, put pressure on unit labour costs, housing will add a couple of ticks, and we see oil higher in 2018 given that current pricing doesn't support positive cash flow for the marginal supplies needed from the United States."
Regional housing market booms have not yet had an impact on CPI because they've been offset by low mortgage rates and because CPI measures factor in builders prices which typically lag behind secondary market prices.
"Statistics Canada has advised us that a change in methodology for housing inflation is forthcoming, and we're guessing that a measure for house prices could be part of that change. But the key to why house prices have been MIA is that mortgages have been generally rolling over at lower rates in the last several years. That's about to change," he says.
The report says the CPI for mortgage interest will accelerate from roughly zero to well over 3 per cent by mid-2019.
"That looks dramatic but given the modest weight of this one component, it would add only 0.2% to total CPI. In sum, a giant leap for MIC, but a small step for total inflation," Mr. Shenfeld says.
According to the report, one factor holding down inflation has been unit labour costs, which have decelerated in recent years. While, more recently, compensation has accelerated as unemployment dropped, that has been offset by surging productivity, with unit labour costs easing to a slim 0.4 per cent annual growth rate through the first quarter of this year.
"Looking ahead, the compensation component should see further pressure, as it captures the lagged impacts of the recent tightening in Canadian labour markets on wage settlements," says Mr. Shenfeld. "In addition to that invisible hand of markets, higher minimum wages in Ontario, BC and Alberta will be kicking into labour costs in the next two years."
Productivity, in contrast, might simply have been rebounding after an earlier period of unusual sluggishness, the report says.
"If recent quarters are not the start of a productivity boom, and output per hour reverts back to it medium-term trend, compensation gains will translate into a meaningful recovery in unit labour costs," Mr. Shenfeld says.
Trends in food should also support a stronger inflation rate.
"A persistent drag over the past several months, grain prices appear to be firming. Even if the food basket only levels off in seasonally adjusted terms, built-in gains in recent months would see food's 12-month pace accelerate from -2 per cent early this year to over 0.5 per cent," Mr. Shenfeld says.
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For further information: Avery Shenfeld, Chief Economist, CIBC Capital Markets, at (416) 594-7356, [email protected], or Susan Kirwin, Senior Consultant, Public Relations, 416-980-5192 or [email protected]