The May spike in headline inflation adds pressure on Bank of Canada Governor Mark Carney to possibly signal an interest-rate hike for September.DARRYL DYCK
Score one for the economists who have been arguing for months that inflationary pressures were mounting and that the Bank of Canada should move off of the sidelines sooner than later to keep price gains under wraps.
The hotter-than-expected inflation reading for May took just about everyone else by surprise, probably up to and including Mark Carney, the Bank of Canada governor. That adds considerable pressure on Mr. Carney to acknowledge this in some way next month when he releases his latest quarterly forecast, possibly by signalling an interest-rate hike for September.
However, a closer look at the data -- and at comments Mr. Carney has made recently -- suggest it would be foolish to assume the central bank is going to start preparing an aggressive tightening campaign.
First, while the overall annual inflation rate accelerated to 3.7 per cent -- the fastest pace since 2003 and the third straight month that the year-over-year pace has exceeded the upper limit of the central bank's comfort zone -- that figure was driven by gasoline prices that aren't exactly set to plunge but are clearly coming down. Prices at the pump in May were almost 30 per cent higher than a year earlier, Statistics Canada said, but they were already moderating by the end of the month and will drop further as the effects of the International Energy Agency decision to release some global stockpiles are fully felt.
Still, even without gas, the main inflation rate quickened to 2.4 per cent from 2.2 per cent, well off of the central bank's so-called optimal target of 2 per cent. That's a little more disconcerting for Mr. Carney and his policy team, since it's attributed to food prices being much higher than a year ago, a dynamic that's less likely to dissipate as quickly as high energy costs, given that the pressures on food production (exponential growth of a middle class in emerging markets, for instance) are arguably more permanent than what drives spikes in gas prices (turmoil in the Middle East, for example).
Yet, if you strip out gas, food and other volatile items, the annual "core" rate of inflation undeniably accelerated, to 1.8 per cent from 1.6 per cent, but stayed under the bank's target. Core inflation over the last 6 months, though, is above 2 per cent, and the three-month core inflation rate is at an eight-year high of 3.8 per cent. If you accept that big wage gains are just around the corner as a result, then that would lead you to believe price increases will continue to compound and, before you know it, policy makers will have a problem.
Remember, though, that Mr. Carney has been saying for months that energy costs and other temporary factors like last year's introduction of the Harmonized Sales Tax would skew the inflation data, keeping the headline number above 3 per cent for a while. Both measures of inflation will "converge'' around 2 per cent by mid-2012 as excess capacity in the economy is absorbed, Mr. Carney said as recently as last week. That sure doesn't sound like a central banker who's caught way off his guard.
The key thing to watch for in July, when Mr. Carney releases his latest forecast, is whether he now sees the slack in the economy disappearing before his current timeline of mid-2012. The argument of inflation hawks has always been that a policy rate of 1 per cent is far too low and that Mr. Carney needs to get cracking to get it to a more appropriate level before mid-2012 or he'll lose his grip on inflation. But even then, Mr. Carney has indicated that the so-called neutral rate for monetary policy is lower than it used to be, given the global economy's ongoing struggle to sustain a robust recovery from the worst downturn since the Second World War.
Last week, he told a Senate committee that he is "in no way incapacitated'' by economic headwinds such as the high dollar, the lack of meaningful progress in the U.S. labour market or the European debt crisis, and can raise rates if he feels the need to do so. But he also told The Wall Street Journal in an interview that policy may need to remain "stimulative'' for longer, given all the risks.
The hot inflation reading for May strongly suggests Mr. Carney won't be able to keep rates on hold through the rest of the year, as financial markets and an increasing number of economists had been predicting. Nonetheless, taking all the facts together, here's betting he acknowledges in July that the domestic side of the equation is more ready for a rate hike, while reminding that the external picture is murky and leaving himself wiggle room to assess whether the current "soft patch'' in the global economy is really just that.