Canada

Canada’s Inflation Hits A Low For 2017, Making An Increase In Interest Rates Tricky

Canada’s Inflation Hits A Low For 2017, Making An Increase In Interest Rates Tricky

Inflation may be turning to deflation sometime soon. Statistics Canada released their monthly update of the Consumer Price Index (CPI), which was unusually low. The indicator has been  trending lower for the past few months. This makes a near term rise in rates unlikely, and actually brings the possibility of cut.

CPI Rose 1.3% Year-Over-Year In May

May saw an increase in CPI when unadjusted, but it was well below the Bank of Canada (BoC) target. CPI rose 1.3% year-over-year in May, slipping even further than last month’s 1.6%. Statistics Canada claimed the decline was mostly due to a drop in food and energy costs. The BoC targets a rate of 2% for a well balanced money supply.

Source: Statistics Canada.

Seasonally Adjusted, CPI Fell 0.2% In May

Seasonally adjusted, the rate of CPI was even lower. The adjusted CPI numbers show a decline of 0.2% in May, after rising only 0.4% in April. Seasonally adjusted numbers are preferred when tracking price trends moving forward. Whereas unadjusted numbers are typically used for adjusting wages.

Source: Statistics Canada.

Hiking Interest Rates Unlikely Without Improvement

One of the primary reasons that the BoC would cut or raise rates would be in relation to the CPI. If the number is too high, it implies inflation may be getting out of control. Raising rates would cool consumer spending, which businesses respond by slashing prices and lowering the CPI. When the CPI falls too low, the BoC cuts rates to stimulate consumer spending. This stimulates inflation and raises CPI closer to their target. The current levels are trending lower, which means a rate cut would lead to deflation.

Raising Rates and Potential Deflation

Declining prices on goods sounds great, but it’s indicative of a recession. Prices declining is a sign that the inventories of goods are being cleared at a lower sale price. If prices trend lower for too long, production gets slashed. After all, who keeps excess inventory of things that aren’t making money? This unfortunately creates a smaller workforce, which people respond to by saving. This further propels the economy lower until a force of some sort stops it – like cheaper credit.

Increasing rates would likely cool housing prices, but might trigger negative CPI if done at the wrong time. Having lower cost housing would be great, but a weakened economy would likely make the cheaper home prices just as hard to palate without that free cashflow. What is a central banker to do. Hm…

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3 Comments

  • Reply
    Lahdeedah 3 months ago

    Great post, and an antidote to the other blogs out there claiming that a sooner-than-expected hike in rates will occur as early as July. Yet, who is to know the right answer?

  • Reply
    Sand 3 months ago

    What is the impact of increasing interest rate spreads spreads between Feds & BOC? Will C$ decline causing increased CPI and help exports?

  • Reply
    Justin Thyme 3 months ago

    ‘BIS considers anything above 2 to be a strong gap, and anything above 10 to be a critical warning. Breaching 10 results in a banking crisis in two-thirds of economies, within three years’

    I believe this is basically what I said in my response a few days ago to the article linking GDP-per-square-kilometer to the rate of increase in housing prices.

    If housing prices increase substantially higher than the GDP-per-area rate of increase, the economy is actually getting relatively poorer and can not support the higher prices, so something has to give.

    Same as inflation. When inflation increases slower or equal to the rate of increase in GDP, the economy is getting wealthier. When inflation is greater than the rate of increase in GDP, the economy is getting poorer. When the rate of inflation is equal to the rate of increase in GDP, as it pretty much is today, the economy is stagnant, even though the GDP and inflation are growing.

    However, you do have to fit interest rates into the equation, and today all three (inflation, interest rates, and GDP growth are all the same. Economic growth stagnation. So when the debt ratio is going up, there is absolutely no new money to pay the debt off, and keep spending at the same rate. Ideally, all four have to be in equilibrium (I suspect it is a net relative constant product among the four) – debt ratio increase, inflation, interest rates, and rate of GDP growth. If the net product of all four gets out of whack, there is inevitably an economic downturn until the numbers get back in line.

    However, I have yet to see an economic theory that links all four together in a universal fundamental equation.

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