Canadian inflation should be smooth sailing, coming in low and stable from now on. A small catch though — your cost of living may not actually see low inflation. Statistics Canada (Stat Can) consumer price index (CPI) data shows an unexpected slowdown in June. The popular interpretation for today’s release is, this proves high inflation is transitory. At least one “Big Six” bank thinks this is most definitely not the case.
National Bank of Canada (NBC) argues recent growth shows acceleration, not a slowing. In a note shared with clients, they explain rising costs are more sticky than presented. Though that may not show up in Canada’s official data.
The bank’s economists warn recent changes in methodology will chronically underestimate inflation. They went so far as to rhetorically ask if the agency thinks this is the best way to serve Canada. That’s basically the economist equivalent of throwing down your hockey stick.
Canadian Inflation Decelerated In June… Sort Of
Let’s start with the headline numbers that were released. The agency reported CPI increased 0.3% in June, down from the 0.5% increase seen in May. A deceleration was also seen for the annual rates as well.
The annual rate of growth fell to 3.1% in June, down from 3.6% in May. The latter had been the largest print since 2011, so the decline in rising costs was more than welcome. Stat Can attributes the deceleration to the base effect, helping to lower growth. Recent data shows high inflation wasn’t just a base effect issue though.
Canadian Consumer Price Index Basket Weight Change
The annual percent change for the Canadian consumer price index (CPI).
Source: Stat Can; Better Dwelling.
Not Just A Base Effect: Recent Growth Has Been Ripping Higher
NBC economists shared their take, explaining recent inflation has been running hot. The 3-month annualized rate of growth reached 4.4% in June. The 3-month. Recent growth has been higher than the annual rate. To see the annual rate decelerate is a little odd, but the point is, it’s not just a base effect. Inflation has been accelerating recently, not only in comparison to last year.
“While some may point to this latest report as an example that recent inflationary pressures are a transitory phenomenon, we maintain our view that inflation should be somewhat sticky in the medium-term,” said the Big Six bank to its financial markets clients.
Canada Changed Inflation To “Better” Reflect Pandemic Spending
Last week we discussed changes to the CPI basket weight, and why it would flatten inflation. For those that need a recap, they’re placing more weight in areas that have seen costs soar in 2020. This might sound like a good idea, but the price increases were thought to be transitory. The areas of the basket that gained points, are taking them away from areas where consumption was low… due to artificial constraints.
To be blunt, they’re putting emphasis on areas likely to see a correction in prices. This will make transitory costs seem deflationary. At the same time, they reduced the weight in areas with temporary reductions in spending. This will lower the impact of components where costs are expected to rise. Overall, inflation will be much lower than in reality. One week later, we have our first Big Six bank that agrees with our take.
Stat Can Is Making A “Mistake,” And Will Underestimate Inflation
NBC sent clients a special “methodological note” on the basket update used for June. Stat Can updates the basket every two years, with 2017’s update used to create inflation points up to this past May. They didn’t use a 2019 update they created. Instead, they made another in 2020. Instead of a stable period, they wanted to “better reflect” pandemic spending habits. The emphasis quote was from NBC, in case you’re curious
The bank said this would be a “mistake” to adjust spending habits to a period of unnatural spending. Now the basket reflects spending patterns established in 2020, which were totally normal. Toilet paper, Lysol, cannabis, and liquor are the only things people will buy from now on, right?
As for the areas you didn’t spend on? Those now represent a smaller portion of the inflation basket. “The items whose weights are expected to increase in the consumer basket as the economy reopens (transportation, gasoline, recreation) will therefore occupy too small a place in the new basket,” said the bank’s economists.
Adding, “since we expect these categories to experience the largest price increases in the near future, official inflation data is likely to keep underestimating inflation pressure going forward.” Stat Can is introducing a statistical bias designed to reduce inflation readings. They’re going to perpetually do it going forward as well.
Canadian Consumer Price Index Basket Weight Change
The point change in the consumer price index (CPI) based weight from 2017 to 2020.
Source: NBC; Stat Can; Better Dwelling.
The agency plans to update the inflation basket on an annual basis from now on. This will constantly increase basket weights for temporary surges, and emphasize corrections. NBC questioned whether this move is of any public value. It certainly doesn’t appear to be.
“We are not sure this is the best way for Statistics Canada to achieve its goal ‘to ensure that the CPI reflects the price change experienced by Canadians’,” they wrote.
We know, it sounds like just nerd talk, but this can have some serious consequences. Monetary policy is based on CPI, and minimizing it will lead to loose conditions. Stimulus effects become less effective the longer they exist, so this won’t be a boom to the economy. The positives, such as higher consumption, will normalize to an overly loose system.
Instead, the negative consequences would become more pronounced. For example, indexed pay increases wouldn’t capture the reality of rising costs. The same issue crops up with pensioners, who are heavily impacted by inflation. The gap between inflation pay increases and the actual cost of living will compound. This could lead to an even faster rise of inequality, with every basket update.
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