The Weekly Bottom Line: Higher Inflation On The Horizon

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American Highlights

  • Consumer price inflation accelerated to 5.0% year-on-year (y / y) in May, again coming ahead of expectations. High prices for used cars and trucks (over 30% y / y) were a major factor in higher inflation in the month.
  • Jobs continue to grow, to 9.3 million in the latest April data. There are now as many jobs as there are unemployed people in the United States.
  • The Federal Trade Market Committee is meeting to discuss monetary policy next week. No change in policy is expected, but seek migration higher in economic, inflation and interest rate forecasts.

Canadian Highlights

  • The Bank of Canada’s rate hike was the big event this week. As expected, the Bank chose to leave monetary policy unchanged.
  • In a subsequent speech, Deputy Governor Timothy Lane expanded the bank’s thinking. He noted the resilience of the economy and the difficult recovery of the labor market going forward.
  • Inflation is on the radar of the Bank of Canada. The Bank is carefully monitoring supply chain bottles and will take care not to allow persistence on this front to worthless inflation expectations.

United States – Fed meets as inflation rises and jobs soar

The Federal Open Market Committee is meeting next week and will have a lot of thought as it determines its next policy steps. Since August last year, the Fed has been aiming to push inflation above 2% – not for itself, but to allow the labor market to fully recover from the shock of the pandemic. Inflation is now up well over 2% – headline CPI hit 5% year-on-year in May this year – but the labor market is still far from fully recovering – in the same month, employment was 7.6 million (5) , 0%) below its pre-pandemic level in February last year.

Fed officials beat a consistent drum that the acceleration in price growth is “transitional” and reflects the unique circumstances of an economy emerging from a health shock of one in a hundred years. They show the huge gains in prices of used vehicles (Graph 1). Vehicle demand grew due to the lack of public transportation alternatives and supply fell, as production of new vehicles was hampered first by the pandemic and then by a shortage of semiconductors (whose demand also exploded).

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Along with fiscal stimulus, monetary policy has certainly helped bring demand back to the economy. The challenge is that more and more, what seems to be holding back the labor market, is not a lack of demand, but of supply. The disappointing rate of employment growth over the past two months cannot be accounted for by a lack of demand from employers. Jobs in April rose to 9.3 million, the highest level in history and more than 20% above its pre-crisis peak (Chart 2). Now there is actually a job for every unemployed person, the best proportion since January 2020, when unemployment was only 3.5%. Rather, the challenge is that for a number of reasons people are reluctant or unable to perform those jobs.

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This does not suggest that the Fed should raise interest rates next week or even a year from now. Low interest rates may not solve the supply challenges, but tight financial conditions could worsen them. The hope is that when the pandemic ends, many of the supply limits will resolve themselves. For example, people are more likely to engage in jobs that require close interaction with others. However, some of the delays in returning to full employment are likely to reflect deeper reassignment challenges. People who have moved from waiting desks to delivering online orders may not want to go back to their old positions. Or the jobs they did before may simply not exist in the new digital economy.

Analyzing future Fed decisions, look at the evolution of their forecasts. Fed members will clearly need to adjust their short-term inflation views, but longer-term views will be more informative. Similarly, on the economic front, the near future will see more improvement, but with an increasing chance of even more fiscal stimulus along the way – the Senate this week has shown its ability to provide funding for infrastructure as logic continues with China – updates in future years could also come with higher expectations about the federal current exchange rate.

Canada – Higher Inflation On The Horizon

It’s been a pretty quiet week on the economic front for Canada this week. The big event was the intention decision of the Bank of Canada (BoC). As expected, the BoC has chosen to leave the overnight rate at 0.25% and continue the quantitative easing (QE) program operating at its current rate of at least $ 3 billion in purchases per week. The Bank’s messaging did not stray far from what was communicated in the April Monetary Policy Report (MPR). It is expected that sometime in the second half of 2022 an excessive slowdown in the economy will be fully absorbed and the 2 per cent inflation target will be sustainably achieved.

The Bank further strengthened its thinking in a speech by Deputy Governor Timothy Lane. The deputy governor noted that despite economic growth less than expected in the first quarter of this year (effective: 5.6%; MPR: 6.5%), the details below tell of a more robust economy. A key element behind this resilience is the growing adoption of digital technology by businesses and consumers to avoid obstacles posed by the pandemic and related constraints. Indeed overall 2020 was a devastating year for the economy, but the digital sector still grew by 3.5% (Chart 1).

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However, the accelerated pace of digitization creates challenges. In particular, the transformation could eliminate some jobs, while exacerbating agile mismatches that are likely to occur when the economy emerges from the pandemic. Monetary policy will have to help, as this excessive slowness is being reabsorbed into the economy.

At the same time, there are significant risks that could leave the Bank of Canada with little choice but to remove a monetary stimulus sooner rather than later. First, vaccination in Canada has progressed more rapidly, and as such, the economic recovery during the summer months could be stronger than anticipated. For two, price pressures are rising, increasing the chances of higher inflation in the coming months.

The BoC will closely monitor developments in inflation. Just south of the border, May was another hot month for inflation. Consumer prices rose by 0.6% m / m, bringing the overall inflation rate to 5.0% y / y, the highest since August 2008. A major reason for this increase was the rise in prices of used vehicles, which mostly is due to scarce semiconductor chips, which severely limited automatic production.

Canada could see a similar price phenomenon as provinces reopen their economies (Chart 2). Next week’s May inflation data is unlikely to include significant reopening effects, as restrictions still apply across much of the country, but provocative shocks could emerge. It would not be surprising to see an increase in vehicle prices next week.

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Like the Federal Reserve System, the BoC expects the supply limits to be temporary. But the danger is that if they are more persistent, it could dampen consumer inflation expectations, leading to a self-fulfilling cycle of rising price growth. The Bank will be cautious about this. If a reopening goes well in the coming weeks, the Bank is likely to further reduce the QE program, perhaps immediately in July.

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