Today's economy

Low inflation signals no change in interest rates

By Kevin Press,

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We received another signal Friday that Canadian interest rates will remain low. Consumer prices were up just 0.2% in August, relative to the month before. Compared to August 2011, the Consumer Price Index (CPI) rose just 1.2%, a tad slower than the 1.3% annual growth rate recorded by Statistics Canada in July.

Image of red shoes on sale - prices for shoes and clothing have dropped.“A lot of categories were quite weak, it’s not just one particular source,” said Emanuella Enenajor, an economist at CIBC World Markets. She and I spoke Friday morning.

Food prices rose the highest year over year: They’re up 2.2%. The health and personal care category rose 2%; transportation is up 1.8%; household operations, furnishings and equipment rose 1.3%; alcoholic beverages and tobacco products rose 1.2%; recreation, education and reading rose 1.1%; and shelter rose 1%. Clothing and footwear is the only category that saw prices drop: That’s down 1.2% relative to a year ago.

“What it says about the state of the economy is that growth is really too weak to see stimulative interest rates,” Enenajor told me.

Canada’s core inflation rate – which is calculated by pulling eight of the least-stable CPI categories out – is 1.6% for the year ended in August. That’s down from 1.7% the previous month. The result is below the Bank of Canada’s 2% core inflation target, but it’s inside the 1% to 3% band it considers acceptable.

“The Bank of Canada is OK with what they’re seeing in terms of inflation,” said Enenajor. “They missed a little bit on core inflation for the third quarter; it looks a bit weaker than expected. But it’s still well within their tolerance band.” The Bank had predicted third-quarter core inflation to be at 1.9% year over year.

Clearly though, we have no reason to worry about inflation for the time being. Coming out of the financial crisis, it was feared by some that government stimulus programs would spark inflation. That hasn’t materialized. In fact, Ottawa’s stimulus effort is now winding down. That’s partly to blame for the relatively soft economic growth we’ve seen in recent reports.

“The government’s spending plan has largely been wearing off,” Enenajor explained. “As a result, you’re seeing the economy slow to some extent. Government can’t spend above trend forever. It has to eventually get back to something more reasonable and in line with their share of the economy and their own budget. The fact that we’re seeing a coming-off of that is one of the factors that are causing growth to slow.”

Monetary stimulus remains a factor, of course. The Bank of Canada’s 1% overnight rate is contributing to economic growth, such as it is. If inflation remains low, that’s one fewer reason to expect a hike in interest rates. It doesn’t rule out an increase in the overnight rate, but it does make it more likely that we won’t see a move by the Bank for some time. The second half of 2013 would be in line with expectations.

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