No inflation problem in Canada

As reported here, inflation in October surprised on the upside in Canada.  But let's not get too excited about this - the inflationary monster is hardly about to rear its ugly head!

To be sure, there was some surprisingly larger than normal increases in some of the categories monitored by Stats Can in October (especially clothing, insurance, textbooks and autos). Higher energy prices were also at play and we know how volatile they can be. But when you really scrub the CPI data, you hardly get any real common theme that suggests inflationary pressure is building on a wide range of goods and services. If anything, I think the surprise in October should really be viewed as a "one off" and more a reflection of the past firmness in the domestic economy than anything else.

In fact, the forward looking indicators suggest that there is little motivation for excessive inflation to take hold. For example, GDP growth in Canada has slowed down significantly to below its potential rates so its not strong enough to absorb the huge amount of excess slack that still lingers in the economy since the 2008 recession. As any business owner realizes, when you have considerable excess capacity and only moderate demand for your products, you hardly have any power to raise your prices.

Another factor for Canada is the higher loonie which should make the costs of imported goods cheaper. There are time lags for this factor to take effect on a retail level, but competition should ensure that it will happen over the next several months.

Now, I do think there are some isolated areas where we will continue to see some upward pricing pressure building. But many of these areas like hydro and the lingering effects of the HST are legislated and not really indicative of market forces. So when you put it all together, the core rate of inflation (which strips away the volatile effects of energy and taxes) should remain below 2% in Canada for quite some time. Since this is the inflation measure that the Bank of Canada watches and it continues to sit below the midpoint of the Bank's target range of 1-3% , I think it gives the central bank  enough room to hold off on rate hikes for at least the next 6-8 months.