the rennie brief: inflation - June 2020


WHAT YOU NEED TO KNOW ABOUT CHANGING CONSUMER PRICES IN CANADA • Canada’s Consumer Price Index fell by 0.4% in May 2020 after declining by 0.2% in April—the first such instances of deflation since the Great Recession of 2008/9 • In contrast to the range of employment changes across the country, all provinces and regions are experiencing deflationary pressures, if not outright deflation • The decline in the overall price level has been led by falling gasoline, clothing, and transportation prices; health care, shelter, and food prices have risen modestly • Continued deflation and/or inflation below 2% will push the Bank of Canada to maintain low interest rates for the foreseeable future to stimulate the economy

the rennie brief

18 JUNE 2020

Canadian inflation was negative for the second straight month in May, reflecting reduced spending and an economy that is functioning well below its potential.

a 0.2% decline, and Ontario and Quebec matching the national figures (a 0.4% drop). Here in Metro Vancouver, prices fell by 0.2%. The last time Canada experienced annual deflation was amidst the fallout from the 2008/9 Great Recession, when prices fell for four consecutive months between June and September 2009. Notably, inflation did not reach the BoC’s target of 2% for another 13 months following that deflationary period, reflecting as it did the slow economic recovery that followed. PRICES DOWN FOR SOME THINGS BUT UP FOR OTHERS While the overall rate of deflation is garnering most of the attention, the overall decline in prices belies a pattern of not only falling prices for some products but an increase in the prices of others. Not surprisingly, categories in which Canadians have not been spending (or been able to spend) their money have experienced deflationary pressure, led by an almost 30% annual drop in gasoline prices, a 5.4% decline in clothing and footwear prices, and a 3.0% dip in transportation prices. Where prices have increased, they have done so only modestly, with alcohol and tobacco prices rising 0.2%, health and personal care by 0.9%, shelter by 1.0%, and food—the quickest to rise—at 3.0%. Overall, when excluding gasoline, the CPI rose by only 0.7% in May, its slowest annual pace since January 2013. INFLATION & INTEREST RATES: THE PATH AHEAD With Canada and its provincial and regional economies currently functioning far below potential, and our expectation of a slow-and-steady return to full capacity, our outlook is for inflation to remain negative to slightly positive in the near-term. In response, the BoC is likely to maintain interest rates close to their current historically-low levels, which will of course have its knock-on effects for other interest rates throughout the economy.

WHAT IS INFLATION AND WHY DOES IT MATTER? The economy’s official rate of inflation is calculated as the annual change in the Consumer Price Index (CPI), which has been constructed based on a fixed basket of goods and services that Canadians purchase. Since 1991, the Bank of Canada (BoC) has worked to ensure that the national rate of inflation has remained in a range of 1% to 3% annually, with a target of 2%. When inflation is high and rising, the BoC will typically increase its short-term (“overnight”) policy interest rate to create a savings incentive and slow economic activity; when it is low, or when the economy faces sudden headwinds like the ones it has recently, the BoC will reduce its policy rate to encourage spending and spur economic growth. In turn, these changes have implications for other interest rates, including but not limited to those associated with savings accounts, lines of credit, auto and student loans, and mortgage rates. Why is it important to manage inflation? When inflation is consistently high—which was the case most recently during the 1980s and in the lead-up to inflation- targeting that was implemented by the Bank of Canada in the early-1990s—the value of money erodes quickly, creating both a disincentive to save and price distortions throughout the economy. When overall inflation is too low—or negative (deflation)—it serves as a signal that the demand for goods and services is lower than it should be, which in turn can further slow economic growth. PRICES IN CANADA FELL AGAIN IN MAY The latest data on changes to the CPI show that annualized inflation was negative in May (at -0.4%) for the second straight month. There was some, but not much, variation in the rates of inflation across Canada, with Alberta seeing prices rise 0.1% (the only province to experience an increase), British Columbia experiencing

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