Inflation Awakens

The weather may be heating up, but with the Stanley Cup finals in full swing, hockey’s the hot item in Canada. The link to the economy? Well, there are many, but what comes to mind is the hockey stick. It strikes fear, not as a lethal weapon, but because of its shape. Lay it horizontally, and it’s a boring, long shaft until the sudden upturn of the blade. Any data series like that is alarming – especially if we’re talking prices. Does this match what we’re seeing in the economy now? Let’s take a look.

Price indexes have generally been a snoozer in the post-recession period. The collapse in 2009 was terrifying, but momentary. It was quickly erased as the effect of aggressive government spending measures ricocheted across the globe, followed by a protracted period of tepid gains. If there was a concern at this point, it was that disinflation – price increases that were positive, but at or below the lower bound of central bank target growth – would turn into outright deflation. If inflation is a worry, the ‘d’ word strikes terror into the hearts of avid economy-watchers, who know there’s a well-versed playbook for the former, but not the latter. Thankfully, most nations have staved off deflation – but is inflation coming back?

It sure looked that way a few months ago. Weak energy prices suppressed overall prices through the first half of 2015, but while energy costs continued weakening through the year, their dampening effect was more than offset by rising prices of other things. In fact, strip away energy and food costs, and so-called ‘core’ consumer prices in the US lurched up on a year-to-year basis to 2.3 per cent, a rate not seen since early 2012.

The pattern was the same in the EA-19, although the growth rate was much lower. Even so, it gave hope that the worst moments of disinflation were a thing of the past, and that the economic zone was at long last getting back to a state of balance between supply and demand.

Here in Canada, the hockey stick turned up sooner. The energy price plunge had the same effect here as in the US and Europe, dampening the early part of 2015. But things have turned up since then, again, in spite of further weakness in energy prices. Is this a concern? Perhaps; Canada is not in the same growth position as the US economy, where increasing domestic demand is putting pressure on labour supply and industrial capacity. Here, we are dealing with the implosion of the energy sector, housing starts that are generally overbuilt, and heavily-leveraged consumers. Yet look at core inflation, and the ‘weakness’ story isn’t as clear. Net of the most volatile prices, Canadian consumer prices jumped up quickly back in mid-2014, tipping over the critical 2 per cent mark, where they have stayed since. They’ve been stable enough to stave off worries, but on balance, there’s not much wiggle room.

Should any of this recent movement cause alarm? Actually, a little inflation is not a bad thing, if it means that deflation fears are behind us. But one can’t get too cozy. After all, there’s still the lingering excessive liquidity of US quantitative easing, and the crisp bills of recent EU and Japanese QE programs threatening to drive prices up. There are also the recent Fed statements, which strongly suggest further rate tightening this year. Is increasing inflation vigilance justified?

Look at very recent price movements, and you might agree. Annualize movements in US CPI over the past three months, and you get 4 per cent growth. Rebounding energy prices are partly to blame, but core rates have jumped to as high as 2.8 per cent recently. In Europe, a less-compelling story: negative price movements have suddenly turned into 2 per cent growth, but core prices are much more modest. Again, Canada surprises: while the three-month moving average of all-items CPI is basically flat, core prices have risen to an annualized 2.3 per cent – possibly reflecting the effect of the weaker Canadian dollar on import prices.

The bottom line? There’s no reason for alarm – yet – but recent consumer price increases are an eyebrow-raiser. Protracted sluggish growth can lull the economy into a state that makes it hard, initially, to cope with higher demand. Today’s price blips might be a hint that pressures – at least in the US – are building.

This has been written by Peter Hall, EDC Vice-President and Chief Economist.