In­fla­tion pres­sure is to­mor­row’s prob­lem

The Globe and Mail (Alberta Edition) - - REPORT ON BUSINESS WEEKEND - DAVID PARKIN­SON dparkin­son@globe­and­

Eco­nomic growth shows that Cana­di­ans can breathe easy for now, but it is only a mat­ter of time un­til in­fla­tion rates come to a head

Canada’s April con­sumer price in­dex re­port shows that this coun­try doesn’t have in­fla­tion pres­sures to worry about yet. But look­ing at the strong retail-sales fig­ures re­leased at the same time, the op­er­a­tive word is “yet.”

Sta­tis­tics Canada re­ported on Fri­day that CPI in­fla­tion was 1.6 per cent in April, un­changed from March and a tick be­low econ­o­mists’ con­sen­sus ex­pec­ta­tion of 1.7 per cent. What’s more, the three mea­sures the Bank of Canada uses to as­sess core in­fla­tion (CPI-com­mon, CPI-me­dian and CPI-trim) were also cool in the month, av­er­ag­ing just 1.4 per cent.

The whole point of core-in­fla­tion mea­sures is to gauge un­der­ly­ing in­fla­tion pres­sures across the econ­omy by screen­ing out the month-to-month noise in in­di­vid­ual com­po­nents that can cloud the broader trend. With the core mea­sures not only firmly be­low the cen­tral bank’s 2-per-cent in­fla­tion tar­get but ac­tu­ally drift­ing down­ward in re­cent months, the sig­nal to the Bank of Canada is that in­fla­tion re­mains be­nign – which means ab­so­lutely no need to raise in­ter­est rates at the cen­tral bank’s next rate de­ci­sion on Wed­nes­day.

In con­trast, other eco­nomic in­di­ca­tors are giv­ing off a con­sid­er­ably warmer sig­nal. The lat­est in­stance was Statscan’s March retail-sales re­port, also re­leased Fri­day morn­ing, which showed that sales rose a solid 0.7 per cent from Fe­bru­ary, well above econ­o­mists’ con­sen­sus es­ti­mate of 0.3 per cent. On a vol­ume ba­sis, sales were even bet­ter, up 1.2 per cent. Statscan also up­graded its April fig­ures to a de­cline of 0.4 per cent from the orig­i­nally re­ported 0.6 per cent. Be­tween the re­vi­sion and the bet­ter-than-ex­pected March bounce, con­sumer spend­ing looks con­sid­er­ably stronger than econ­o­mists had thought.

Add that to other strong eco­nomic in­di­ca­tors for March – in­clud­ing im­pres­sive gains in trade and in man­u­fac­tur­ing sales – and there’s no ques­tion that Canada’s econ­omy shifted into a higher gear in the early months of this year. In light of the retail re­port, Bank of Nova Sco­tia econ­o­mist Derek Holt es­ti­mated that firstquar­ter real GDP growth may come in at some­thing ap­proach­ing 4.7 per cent – which would be the strong­est quar­ter in more than five years and well above the Bank of Canada’s es­ti­mate of 3.8 per cent. And with an ap­par­ently im­pres­sive end to the first quar­ter, the econ­omy looks to have car­ried mo­men­tum into the sec­ond.

So far, this eco­nomic mo­men­tum hasn’t man­i­fested it­self in the in­fla­tion num­bers. But if it con­tin­ues, it inevitably will – it’s only a mat­ter of time.

For the Bank of Canada, the key to as­sess­ing the po­ten­tial for a buildup in in­fla­tion­ary pres­sures is the out­put gap – the dif­fer­ence be­tween how much the econ­omy is ca­pa­ble of pro­duc­ing and how much it ac­tu­ally is pro­duc­ing. When that gap closes, the econ­omy lacks ca­pac­ity to meet new de­mand, and that tight­ness forces prices higher. Mr. Holt be­lieves the econ­omy’s gen­er­ally strong growth over the past sev­eral months has ef­fec­tively closed the out­put gap un­der one of the two mea­sures the Bank of Canada uses (the ex­tended mul­ti­vari­ate fil­ter, a gauge the cen­tral bank has re­lied on for al­most two decades), while the gap is nar­row­ing by the other mea­sure (the in­te­grated frame­work, a rel­a­tively new in­no­va­tion).

By the cen­tral bank’s own ad­mis­sion, an out­put gap is a hard thing to mea­sure, and both the gauges it looks at are, at best, rough es­ti­mates. For that rea­son, the bank also leans on in­di­ca­tions from pro­duc­ers in the econ­omy, via its quar­terly Busi­ness Out­look Sur­vey, to get feed­back from the cor­po­rate trenches on ca­pac­ity pres­sures that could add colour to the sta­tis­ti­cal mod­els. But the next sur­vey won’t be pub­lished un­til the end of June.

In the mean­time, it might be use­ful to con­sider not those un­de­ni­ably cool year-over-year in­fla­tion rates, but the trend in con­sumer prices more re­cently, in the pe­riod in which eco­nomic ac­cel­er­a­tion has been ev­i­dent. Af­ter a lull in the sec­ond half of last year in which the con­sumer price in­dex ac­tu­ally de­clined, CPI has jumped 1.6 per cent in the first four months of 2017, the most in­fla­tion­ary four-month stretch in three years.

That’s prob­a­bly too short a pe­riod to de­clare a “trend,” but it’s no co­in­ci­dence this has come dur­ing a stretch of par­tic­u­larly strong eco­nomic growth. As long as the growth story re­mains in­tact, in­fla­tion is go­ing to move from a non­starter to an essential part of the eco­nomic con­ver­sa­tion.

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