Slowing inflation might be a popular take in the media, but it’s not what the central bank is seeing. The Bank of Canada (BoC) explained headline inflation fell from 8.1% to 7.6% in July, due to gasoline prices. This makes it appear that inflation is falling, but that’s not really the case.
In a statement today, they explained core inflation continued to rise from 5% to 5.5% in July. This implies inflation is still climbing, reinforcing the need for higher interest rates.
For those unaware, core inflation is the central bank’s preferred measure of inflation. It reduces the impact of volatile components like gasoline, reducing any bias. Core inflation tends to only rise when a more general price increase is observed.
“…inflation excluding gasoline increased and data indicates a further broadening of price pressures, particularly in services,” said the BoC.
Adding, “the longer this continues, the greater the risk that elevated inflation becomes entrenched.” Entrenched inflation means there’s no rolling it back, and it can become persistent.
Canada’s Economy Is Expected To Weaken With Global Demand
The BoC warned that Canada’s economy continues to operate with excess demand. Add a tight labor market, and there’s not a lot of slack that can be picked up. Bluntly, the economy is overheated with nowhere to go, resulting in inflation.
Soaring inflation has been chipping away at economic progress across Canada. The BoC points to the 3.3% annual growth of GDP in Q2 2022, below their expectations. By using higher rates, they can slow credit driven demand. Ideally this helps reduce inflation, but in the short-term it will also reduce GDP further.
“The Bank continues to expect the economy to moderate in the second half of this year, as global demand weakens and tighter monetary policy here in Canada begins to bring demand more in line with supply.”
Higher mortgage rates are cooling the housing market too. The BoC explained this was anticipated, following “unsustainable growth” during the pandemic. Financing issues are changing fast, as quantitive tightening (QT) impacts liquidity.
QT reduces credit liquidity, the opposite of the more often discussed QE. Credit growth is expected to slow in the coming months, but they have a long way to go.
Mortgage credit, for instance, continues to grow at nearly a double digit annual rate. It’s much slower than it was during the peak, but mortgage debt is close to the size of Canada’s GDP. It’s also growing over double the rate of GDP, which is unsustainable, to say the least.