Canada’s sky high debt is meeting with higher than expected inflation, and it’s going to be a problem. Statistics Canada (Stat Can) data shows the median consumer price index (CPI-Median) rising in November. The measure of core inflation is now at the highest level in over a decade. By itself, this isn’t much of an issue to worry about. However, due to elevated household debt, the problem analysts have been warning about, is here. The Bank of Canada may have to choose between higher inflation and more debt accumulation, or higher debt costs and lower economic growth.
Median Consumer Price Index (CPI-Median)
Today we’re looking at the median consumer price index (CPI) which is one of the measures of core inflation. It’s calculated using price changes in the 50th percentile, filtering out extreme movements. By excluding outliers, the trend is more in focus. Studies from the U.S. Federal Reserve claim it’s a better prediction of price movements.
CPI-median is different from headline inflation, which is what’s discussed in broadsheets. That stuff, while still important, tends to be more volatile. Consequently, it makes it more difficult to spot trends. Elevated short term spikes in energy one month might skew this index. A drought on another day, might make energy costs more expensive the next. The headline is great for seeing short-term impacts to costs, important in a news context. But it’s too volatile, and requires a lot of trimming and exclusions to extract longer-term trends from.
CPI-Median Hits Highest Level Since 2009
CPI-Median reached the highest levels in over a decade. The rate hit 2.4% in November, up 0.1 points from a month before. This is 26.31% higher than the same month in 2018. The level is actually the highest we’ve seen for CPI-Median since March 2009. Now, this becomes more of a problem for Canada’s credit-driven economy as it gets closer to 3%.
Canadian Median CPI
The measure of core inflation in the 50th percentile of the distribution of price changes. Called CPI-median in Canada.
Source: Stat Can, Better Dwelling.
Higher Inflation Is A Problem For Credit Growth
Inflation and borrowing rates are closely tied together in modern monetary policy. As inflation falls below target, central banks have incentive to cut overnight rates. By cutting rates, they’re making borrowing cheaper. This increases access to credit, helping to boost economic growth. Higher economic growth, should lead to higher inflation. The bigger the cuts, the higher it rises. They generally do this until they hit the target rate, which is 2 percent in Canada. The closer it is to 3 percent, the less likely they are to cut rates.
When inflation is above the target rate, central banks raise rates to cool borrowing. By making it more expensive to borrow, people borrow less, due to rising servicing costs. Inflation typically responds by falling lower. The higher inflation is above the target rate, the more likely an increase in overnight rates. Inflation typically responds by falling, usually over a six to twelve month period.
The current issue is CPI is trending above target, and marching towards the high end of the range. November’s number is the highest in over a decade, and 20% above the target. The higher this number trends (or remains), the more difficult it would be to cut rates. This becomes more complicated when the inflation pressures are energy and food. In order to bring down those prices, a strong dollar is typically needed. Cutting rates tends to weaken the currency. A problem since fuel is priced in US dollars, and so are a lot of food imports.
The BoC left rates at rock bottom levels for a very long time, inflating household credit growth. Canadian households now have some of the highest debt levels in the world. Consequently, this weighs on the BoC’s decision to cut. Do they send borrowing rates higher to save inflation? Or do they cut, and throw gasoline on the inflation fire? Even if you abstained from Canada’s debt binge, everyone’s debt is now your problem.
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The problem with the debt bubble nicely summed up. We borrowed growth during good times, and are now out of options as things get worse.
Canadian dollar moved higher on the inflation data, because they know it means they’ll need to raise rates to contain imported inflation.
The problem with printing so much credit, is we weakened the dollar at a time when it didn’t need to be.
Borrow at 2.69% for 5 years, with inflation at 2.4%. This developing world levels of BS.
Then Poloz has the audacity to say the bubble had nothing to do with him. He’s out next year, so he just wants to be remembered as the guy that made the economy go higher.
Has anyone thought to thank Mr. Poloz for avoiding a financial meltdown the like of which the world has never seen? I wish him well on the next phase of his life’s journey.
“By cutting rates, they’re making borrowing cheaper. This increases access to credit, helping to boost economic growth. Higher economic growth, should lead to higher inflation. The bigger the cuts, the higher it rises.”
What has been happening in Japan in this century for god’s sake?! It’s incredibly frustrating to read this when it is empirically completely false. What has been happening with inflation over the past decade with incredibly low rates?
Lots of evidence that interest rates POSITIVELY correlate with GDP growth: https://www.sciencedirect.com/science/article/pii/S0921800916307510
Yes, because of the perversion of interpretation of Kenyensian economics. Perpetually low interest rates lose their firepower, and GDP growth is consistent with debt levels rising. It makes things worse, because debt driven GDP growth also lowers GDP velocity, causing longer lasting period of low growth. His statement isn’t wrong, it’s just not elaborate enough to counter a completely different argument.
I believe Stephen gets this, since he’s Austrian school. He posted an analysis on rates and GDP velocity a while back, that clearly demonstrated its his opinion. He’s worth a follow on Twitter if you’re not already following him. A surprising amount of Kenyes discussion.
From an empirical standpoint, he is actually wrong. If you look at that paper it tracks back to the 1960s and there’s no evidence to suggest that interest rates had any firepower.
There’s a logical explanation for it as well. The government is a net payer of interest and when interest rates go up, so does the interest income channel. In the private sector the increased interest rates change the distribution of savings and investments (but everything still nets to zero [assets = liabilities]), while the government interest payments represent a net increase in the economy.
Will BOC rate cuts at this point , when rates are all ready this low, have any significant impact on the economy?? I doubt it.
Canadians have had a long history of near zero rates, over 10 years, and the question is will this generation be able to adapt to historic levels of rates..?? Interest rates of plus 6%..
The real inflation rate of food, gasoline , cars, houses, and house taxes.. have risen far more that the political numbers would indicate.
So I’m guessing the future of rates is going higher.
“Canada may have to choose between higher inflation and more debt accumulation, or higher debt costs and lower economic growth.”
I don’t believe there will be much of a choice.
“We are Canada’s central bank. We work to preserve the value of money by keeping inflation low and stable.” Quote taken right off BoC website.
The bank will do what they are mandated to do. If inflation irks higher I would expect a rate raise.
To be seen !
The biggest contributor to the annual inflation rate was mortgage interest cost, with a 6.6% inflation rate for November. If the Bank of Canada’s target inflation indicator were the All-items index excluding mortgage interest the inflation rate for November would be 2.1%, up from 1.7%, instead of 2.2%, up from 1.9%. This change would automatically remove mortgage interest cost from the operational guide as well, applying the same methods for calculating core inflation to the new target indicator. The new operational guide would be showing an inflation rate lower than the 2.2% average over the three measures, up from 2.1% in October. No other central bank in the world has a preferred core inflation measure that is sensitive to mortgage interest costs, and with the exception of the Icelandic central bank, which is thinking of moving to the CPI excluding owned accommodation as its target indicator, no other central bank has a target inflation indicator that is sensitive to mortgage rate changes.