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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SOURCE CIBC