CANADA’S STEADY INFLATION MAY BE TOO GOOD TO BE TRUE
Kevin Carmichael takes a look at evidence that we may not be exceptional after all.
Forget American exceptionalism: We’re the ones defying the rules these days.
The global economy decelerated this year, and international oil prices still are about 30-percent lower than they were before the crash in the autumn of 2014. That should have set up Canada for a bad time in 2019. Instead, we’re pushing through it. As almost every major central bank cut interest rates this summer, the Bank of Canada held firm. The housing market recovered from a slump at the start of the year, and the economy added almost 400,000 positions through September, the best nine-month performance since 2002, according to Bloomberg.
More evidence of exceptionalism arrived on Wednesday, when Statistics Canada reported that we have something most of our peers lack: a little inflation.
One of the biggest themes in economics is the absence of upward pressure on prices in the United States and Europe despite ridiculously low interest rates and impressive job creation. Those conditions are supposed to generate heat; according to the Phillips curve, low unemployment pushes wages and prices higher. But that hasn’t happened, prompting the Economist last week to publish a series of articles under the headline “The end of inflation?”
Not in Canada. The Consumer Price Index (CPI) rose 1.9 per cent from September 2018, pretty close to the Bank of Canada’s target of two per cent. And that’s kind of what you’d expect. Last week, Statistics Canada reported that the jobless rate dropped to 5.5 per cent in October, one of the lowest rates on record, and that the average hourly wage surged 4.3 per cent from a year earlier, one of the fastest increases since early 2009.
“Canada is one of the few with a clear-cut acceleration in wages and a Phillips curve that is sort of working,” Alan Ruskin and Michael Hsueh, foreign-exchange strategists at Deutsche Bank, wrote while explaining why they think the loonie is set to appreciate against the U.S. dollar.
Their note included a chart that shows wages have risen and fallen fairly synchronously with inflation, as measured by the output gap as a percentage of gross domestic product, since at least the mid-1990s. (The output gap is a measure of economic strength that represents the difference between actual GDP and the estimate of the value of goods and services an economy can create without stoking inflation.)
Canada’s dollar jumped about a cent after the jobs numbers were released on Oct. 11 and has held at around US76 cents this week, as more investors join the bet that the Bank of Canada will leave interest rates unchanged at the end of the month. That’s a shift from late summer, when the consensus had the central bank lowering its benchmark rate this autumn as insurance against the trade wars. On-target inflation “should keep the (Bank of Canada) confident in leaving rates unchanged at least through the end of the this year and into 2020,” Veronica Clark, an economist at Citibank, advised her clients in an email.
To be sure, the architects of Canada’s inflation target probably never envisioned that a benchmark rate of 1.75 per cent would be sufficient to keep a lid on prices. In that way, we are no different from the other advanced economies. Borrowing costs remain a long way from what was considered normal a decade ago and they appear to have peaked. That raises all kinds of questions, most importantly the extent to which central banks can be counted on to fight the next downturn. They never got to replenish their arsenals, and private debt is at record levels, suggesting fiscal policy will have to do most of the work during the next recession, an unpleasant thought given the state of our politics.
Canada’s steady inflation also might be too good to be true.
To get a sense of where prices are headed, the Bank of Canada watches three “core” inflation measures that attempt to separate the signal from volatile components of the price basket. Those measures averaged 2.1 per cent in September, only the fifth time that number has exceeded two per cent in 91 months since the start of 2012, according to Derek Holt, an economist at Bank of Nova Scotia.
It could be nothing. Or it could mean executives and investors see the Bank of Canada’s two per cent as a ceiling, not a target, a notion that Stephen Poloz has tried to correct over his seven years as governor. In a healthy economy, animal spirits should test the central bank’s limits by pushing inflation past the target. “There is arguably at least as strong a case for the (Bank of Canada) to attempt at overshoot or tolerate one as there is for Fed,” Holt said.
Recently, Canada’s central bankers have described two-percent inflation as a reason to leave rates unchanged. But prices probably aren’t too hot to stop a cut if the trade wars get worse. We’re not that exceptional.