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Inflation climbs to highest in more than 30 years, raising odds of rate hike next week

Financial Post logo Financial Post 2022-01-19 Kevin Carmichael
Canada's annual pace of inflation rose again in December. © Provided by Financial Post Canada's annual pace of inflation rose again in December.
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Canada’s broadest measure of inflation climbed 4.8 per cent in December from a year earlier, the largest increase in more than 30 years, raising the odds the Bank of Canada will hike interest rates next week to offset gathering cost pressures, and adding to the pressure on Finance Minister Chrystia Freeland to pare federal spending.

Statistics Canada’s consumer price index (CPI), which the central bank uses as a guide to set its benchmark lending rate, was pushed higher by increases in the cost of almost everything. All the eight major components the agency uses to group the hundreds of goods and services it includes in its price basket posted gains last month, evidence that a phenomenon initially driven by input prices has spread throughout the economy.

Notably, food prices surged 5.2 per cent in December as poor weather in major farming regions around the world limited the supply of fresh fruit. The drought that afflicted the Prairies during the summer showed up in the price of bakery goods, which jumped 4.7 per cent from a year earlier, Statistics Canada reported on Jan. 19.

The cost of household appliances jumped almost nine per cent, the biggest year-over-year increase since 1982, further illustrating the extreme mismatch between supply and demand that occurred as the global economy recovered from the COVID-19 crisis far faster than most companies anticipated it would.

Unlike the Great Recession, the world’s richest economies erred on the side of growth in deploying an unprecedented amount of fiscal stimulus, leaving households with lots of money to spend as economies reopened.


Suppliers are still trying to catch up and, as a result, inflation is elevated almost everywhere. For example, inflation in the United Kingdom also surged to a three-decade high in December, according to data released by the U.K.’s statistics agency on Jan. 19. The breadth of cost pressures suggests its past time for governments to step back, rather than continue to stoke demand with stimulus programs.

“There are warning signs on pursuing aggressive government spending in the short term,” said Robert Asselin, a former economic adviser in Prime Minister Justin Trudeau’s government who is now policy director at the Business Council of Canada. “The challenge that lies ahead is to not let policy errors harm the impressive recovery we have seen over the last few months.”

Upward pressure on shelter costs remained intense, stoked in December by a year-over-year rise of 9.3 per cent in home insurance prices, a jump Statistics Canada attributed to higher prices for building supplies and, possibly, an increase in the number and frequency of severe weather events.


The three “core” measures of inflation the Bank of Canada watches to get a clearer feel of pricing trends all posted increases as well, making it difficult for policy-makers to justify their current interest-rate setting of effectively zero, which was put in place when the biggest threat was deflation.

The optics of raising interest rates during another wave of pandemic-related shutdowns will complicate the central bank’s deliberations, but the intensity of the price data appears to leave them little choice.

“It’s clear the bank needs to rein in elevated expectations by removing some excess accommodation,” said Stephen Tapp, chief economist at the Canadian Chamber of Commerce and a former Bank of Canada staffer.

Governor Tiff Macklem and his deputies are currently debating what to do, and will release their decision on Jan. 26, along with a new economic outlook that will almost certainly be positive, given substantial evidence of strength in the labour market and exports at the end of 2021. By almost all counts, Canada’s economy had lots of momentum heading into the Omicron wave and should be able to push through the latest headwind without great difficulty.

“The across-the-board increase in the core inflation measures leads us to think the (Bank of Canada) will err on the side of acting to damp inflation despite new lockdowns,” said Veronica Clark, an economist at Citigroup Capital Markets Inc. in New York, who predicts a quarter-point hike next week, followed by additional quarter-point hikes in April and October.

That trajectory would put the benchmark rate at one per cent by the end of the year, a rate that would still be low by historical standards.

“The economic impact of near-term Omicron disruptions is expected to be significant but largely temporary and existing government support programs will keep a floor under household incomes, backstopping consumer demand,” said Claire Fan, an economist at Royal Bank of Canada. “Against that backdrop, the Bank of Canada is expected to begin hiking interest rates soon, with our own base case for an April hike but with any meeting, including next week’s, a significant possibility.”

The CPI actually decreased 0.1 per cent from its level in November, as gasoline prices eased amid the latest wave of COVID-19 infections. It’s unlikely many people noticed, however, as fuel costs  were still 33 per cent higher than December 2020. Surging commodity prices are a big part of the post-pandemic inflation. Excluding energy, the CPI rose 3.8 per cent from a year earlier, still high, but less extreme than the all-items number.

Macklem at the end of 2021 said he was uncomfortable with the pace at which inflation was accelerating, and the latest reading will do nothing to ease that discomfort. He had assumed a convergence of idiosyncratic forces that had disrupted global supply of goods would fade, and the burst of inflation that came in the aftermath of the COVID-19 recession would dissipate.

That still could happen, but inflation has now persisted long enough to begin changing the public’s expectations of where prices are headed. More than two-thirds of the respondents to the Bank of Canada’s quarterly survey of businesses said they saw the CPI exceeding three per cent over the next two years, the central bank reported earlier this week. The risk now is that inflation becomes a self-fulfilling prophecy.

Three per cent is an important psychological barrier because it’s the outer limit of the Bank of Canada’s comfort zone for inflation. It tries to keep the CPI advancing at an annual pace of about two per cent, the midpoint of the range that begins at one per cent on the low end and extends to three per cent at the high end.

Inflation has now exceeded three per cent since April, by far the longest stretch of off-target price increases since the central bank began using the CPI to guide its policies in 1991, which is the last time inflation was this close to breaching five per cent.

“Inflation is likely to come down over the next year, but getting it there will require tighter financial conditions and rate hikes by the Bank of Canada,” said James Marple, an economist at Toronto-Dominion Bank. “The process is likely to begin this year but bringing inflation back to two per cent is likely to be a multi-year project.”

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