Inflation ‘benign’ so interest rates stand pat

The much-watched consumer price index (CPI)  rose just 1.3% in the 12 months ended July, following a 1.5% gain in June. Even more important, the Bank of Canada's core index added 1.7% in those same 12 months, following a 2.0% gain in June ó putting paid to speculation that the central bank will raise interest rates any time soon.

"We expect this benign inflationary environment to persist in the second half of 2012,î reported TD Bank Group senior economist Sonya Gulati, "given the absence of upward pressure from the usual drivers [such as] oil and gasoline prices. The modest economic growth environment will also do little to drive inflation higher over the near term.î

That will give the Bank of Canada little reason to tighten monetary policy, as it hinted in June (Knowledge Bureau Report, June 6)  when it spoke of "some modest withdrawal of the present considerable monetary policy stimulus.î Gulati sees little action in the overnight rate until March 2013. Bank of Montreal economist Robert Kavcic puts the time for tightening as "well into next year.î And CIBC economist Emanuella Enenajor noted: "While we expect core inflation to recover from its 1.7% pace in the months ahead, it should remain within a range to provide the Bank of Canada with ample justification to stand pat on rates and wait for calmed global economic waters before taking the plunge to tighten policy.î

In the 12 months, every major component of the CPI rose except clothing and footwear, which was down 0.7%. Leading the increase were higher prices in two components: food and household operations, furnishings and equipment. Both were up 2.1% year over year. Higher costs for telephone services and financial services led to year-over-year price gains for the household operations, furnishings and equipment component, says Statistics Canada.

Behind increased food prices were food from restaurants, 2.4% more costly in July than a year ago; meat prices, up 5.3%; and cereal products, costing 3.7% more. In contrast, prices for fresh vegetables declined for the fifth consecutive month.

Still, economists are keeping their eyes on food inflation. Drought in the U.S. is pushing global prices for corn and soybeans higher. Although it will take as much as a year for higher raw food prices to show up on the grocery aisles, CIBC's Enenajor suggests food inflation is likely to "edge upî to 4% in the months ahead.

Even so, TD's Gulati does not see that as threatening: "The food category represents just 14% of the entire consumption basket. As a consequence, the muted inflationary picture ought to continue in spite of these developments.î

That usual driver of inflation, energy prices, was down 1.2% in the 12 months. Natural gas prices dropped 15.2% on a year-over-year basis, continuing a pattern of declines observed since January 2011; gasoline prices fell 1.3% in the 12 months, the third consecutive year-over-year decline. The cost of electricity, however, increased 3.7% year over year, after a 5.9% rise the month before. Increases in electricity prices in Ontario were the biggest factor in this rise.

There is some concern that another much-watched indicator, the Labour Force Survey, may be heralding the onset of wage inflation. As CIBC economist Avery Shenfeld noted in a report entitled "Are Canadian wages really heating up?î: "We have several months in which Canada's widely watched Labour Force Survey has shown accelerating year-on-year wage gains. Average hourly pay for permanent employees, a category tracked by the Bank of Canada, is up 3.9% in the year to July, the sharpest run-up since early 2009.î

That raises questions about the ability of employers to hold the line on wages and about Canada's "output gap.î But in the end, Shenfeld concluded the evidence isn't conclusive. The recent gains may be simply an indication of soft figures a year ago. "If we're right,î he wrote, "as two healthy monthly gains from August to September 2011 drop out of the 12-month calculation, average wages for permanent workers won't look at all troublesome from an inflation perspective two months from now.î