As inflation inches closer to 3%, economists warn progress will stall this year

While inflation inches closer to three percent, economists warn that the steady monthly decline in annual price increases will stop and may even reverse in the second half of the year.

Statistics Canada is scheduled to release its consumer price index report for June next week, and forecasters expect the annual inflation rate to fall from 3.4 percent in May.

“We expect a deceleration to three percent year-on-year. And that is actually mainly because the fuel prices we are paying now are compared to the peaks of what we saw last year,” said Andrew Grantham, an executive director of economics at CIBC.

But inflation is not expected to fall much this year, making the journey back to the two percent target a long and tumultuous one.

Desjardins chief economist Jimmy Jean says the upcoming CPI report marks a turning point in the fight against inflation.

“June is really going to be the peak disinflationary force coming from gasoline, in our view. So I think once we get through that, we’re going to see it take a long time before we get to inflation. one It’s a place we’re happy with,” Jean said.

The rapid decline in inflation since last summer is largely due to base-year effects, which refer to the impact of price movements from a year ago in calculating the year-over-year inflation rate. .

Simply put, this means that prices will not increase rapidly this year because they are compared to the increased prices of last year.

On Wednesday, the Bank of Canada raised its key interest rate by a quarter of a percentage point in part because it expects inflation to remain high for longer.

It released new projections suggesting inflation will return to target by mid-2025. That’s six months higher than the central bank had predicted.

The central bank said the upward revision of its inflation forecast was due to “excessive demand” in the economy, higher than expected housing prices and higher than expected commodity prices.

The Bank of Canada’s key interest rate currently sits at five percent and it has not ruled out further rate hikes if needed.

Grantham said CIBC’s forecast for inflation in the coming months was in line with the Bank of Canada and warned that inflation could rise for several months.

Economists who track changes in price growth have noted that core inflation measures, which strip out volatility, have not fallen much in recent months.

That led the central bank to raise rates, even as inflation appeared to be on the decline.

“Where our predictions differ the most from the Bank of Canada, is what happens after that,” he said.

“We actually think inflation will return to two percent in the second half of next year.”

That’s because there are signs of a softening economy, he said, as well as more development in supply chains.

Canada’s labor market has begun to ease as the unemployment rate rises and wage growth slows. And data from Statistics Canada shows that the rate at which households are saving is declining.

The Bank of Canada’s hawkish side, however, appears to be driven by the housing market, which has bounced back this year despite high interest rates.

“The housing market has seen some pickup. New construction and real estate listings are lagging demand, which increases the pressure on prices,” said the Bank of Canada in its press release announcing the latest rate hike.

Jean said the last two rate hikes have shifted sentiment in many housing markets, although rapid population growth has moderated the impact of rising interest rates on housing demand.

The rapid rise in interest rates has eroded housing affordability, as mortgage interest increases costs for new home buyers and existing homeowners with variable rate mortgages.

In May, Statistics Canada’s mortgage interest cost index jumped 29.9 per cent, the fastest increase on record.

Mortgage interest rates also increase inflation.

Excluding mortgage interest costs, real prices rose 2.5 percent year-over-year in May, well within the Bank of Canada’s target.

Grantham says some of the core measures of inflation tracked by the Bank of Canada don’t include these costs, which he says makes sense.

“Every time you raise interest rates, if everything else remains equal, inflation will actually accelerate,” Grantham said.

“So it doesn’t necessarily make a ton of sense from the point of view of the central Bank targeting inflation, to include costs.”

This report by The Canadian Press was first published July 16, 2023.