Inflation is cooling but prices aren’t going to fall. Here’s why

The pace of inflation is cooling. The annual rate was seven percent in August, Statistics Canada reported this week. That’s down from the four-decade high we saw in June.

But that doesn’t mean the prices are going down. Even the most optimistic scenarios assume prices will continue to rise even as inflation regains control. “It’s more about prices rising more slowly than prices falling,” says BMO economist Benjamin Reitzes.

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The best-case scenario is that higher interest rates and a slowing economy will bring inflation down to a more moderate pace. Right now, headline inflation is decelerating – but it’s mainly being pulled down by a lower global oil price.

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Reitzes says consumers shouldn’t expect that with other goods and services.

A tipping machine that accepts a tip of up to 30 percent can be seen next to a receipt and an empty wine glass in a woman's hand.
The cost of eating out in restaurants has increased since 2020. Even if inflation cools, analysts expect prices at restaurants will continue to rise. (Danielle Nerman/CBC)

“Some prices are likely to go down, like we’ve seen gasoline prices come down,” he says. “But others are on a new higher plateau right now and will only rise more slowly, and that’s what slower inflation is.”

Further rate hikes expected

As higher interest rates raise the cost of borrowing and hamper economic growth, some of the biggest and earliest drivers of inflation are coming back to earth. Oil prices have fallen sharply this year, shipping costs are nearly back to pre-pandemic levels, and prices for key grains and corn have also fallen.

But the cost of food and services is still increasing. Food prices rose 9.8 percent in the year to August. The battle for price reductions will continue. Economists expect the Bank of Canada to move ahead with its plan to raise interest rates again.

“Inflation probably hasn’t slowed far enough or long enough to convince the Bank of Canada that further rate hikes are not necessary,” wrote CIBC economist Andrew Grantham.

That means Canadians, already impacted by higher prices, will be further squeezed by increased debt payments. The economy will slow down and jobs will be lost.

Pedro Antunes, chief economist for the Conference Board of Canada, says we haven’t seen inflation this high in decades, making people forget how insidious it can be.

He says inflation is eating away at our purchasing power. Sure, the cost of just about everything is going up. But wages are not keeping up. In fact, wages are falling, taking into account the increased costs. “Real wages” are calculated by subtracting wage growth from inflation.

Antunes says the gap between wage growth and price growth is now seared into the economy. “We will see that this is a persistent blow to our ability to buy goods and services.”

Gas prices have fallen in recent months, which has helped slow inflation. (Sean Kilpatrick/The Canadian Press)

And while price growth is slowing, it will be a long time before costs are brought back within the window deemed acceptable by the Bank of Canada.

The central bank wants inflation to grow between 1 and 3 percent each year. RBC economist Claire Fan says how quickly inflation can get back into that window depends on how aggressively the Bank of Canada hikes interest rates.

Fan says their projections show inflation won’t return to this window before the end of next year.

“We hope so,” she says. “But that depends on whether the Bank of Canada hikes rates to 4 percent by December.”

But she says Canadians should remember that a slowdown in inflation doesn’t mean prices go back to where they were before all this began.

“A slowdown in price growth is what we’re all expecting, not an outright drop in prices,” she says.

Because the alternative to rising prices is much worse.

danger of deflation

An actual fall in prices would trigger a whole new economic crisis.

Deflation occurs when prices generally fall and the Consumer Price Index, a basket of goods and services, turns negative. Suddenly, people stop buying things, the economy pulls out contracts, and jobs are lost.

“That puts enormous pressure on the economy, it also makes it extremely difficult for central banks to stimulate the economy when you’re in a deflationary environment,” says Reitzes.

It’s also a cycle that’s notoriously difficult to break.

“Just look at Japan,” he says.

Food prices in Canada rose 9.8 percent in the year to August, Statistics Canada reported this week. (George Frey/Bloomberg)

Japan has been struggling with deflation for decades. Various governments and various central bankers have tried pretty much everything to get out of it.

“They did their best to get out of it. They did what they could, the government spent a lot of money and the central bank expanded its balance sheet,” says Reitzes.

It’s been a generation since Canadians have faced such questions. Across the country, people are struggling under the weight of rising prices. The cure is higher interest rates, which put even more pressure on indebted households.

Price growth is slowing. But the surge over the past year has set a new normal. A new level from which, if we’re lucky, prices will continue to rise – just at a more manageable pace.

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