Inflation Is Back


Five months of deflation, the longest period recorded in Canada since 1953, ended last month. Year-to-year inflation edged up 0.1% in October, jumping into positive territory after September’s -0.9%. No matter how small one-tenth of a percent inflation seems to be, questions about the future still arise.

Higher or Lower?

Such simple information about inflation can sometimes explain less than no information at all. If you compare month-to-month inflation, you will find that prices in October 2009 were actually 0.1% lower than in September 2009. So are the prices going up, or down? Answers can be found by taking a closer look at the price index.

Six out of the eight major price index components (including food, shelter, and clothing) rose in October. But the biggest change was caused by the shrinking gap of this year’s oil price compared to last year’s (along with other energy commodities). While in October 2008 oil prices were already declining from the summer peak, current prices are hovering around the $80 level. If you exclude other volatile energy-related components, inflation rose from 1.5% to 1.8%, grabbing more money from our wallets for most consumer goods. Among the provinces, the greatest inflation increase was recorded here in Ontario (from -1.1% to 0.2%).

The Future

Naturally, most investors are interested in the future trend of inflation. On one hand, there are the government’s expansionary policies (particularly the extremely low interest rate, which has been maintained by the Bank of Canada for more than a half a year, and will probably continue for about seven months longer). Another important factor is the quickly disappearing safety cushion created by the large drop in oil prices recorded during last fall/winter. These all are pushing the consumer price index up the hill.


On the other hand, the main opposing force keeping prices down is the ongoing weakness of the Canadian economy. With high unemployment rate (near 9%) and low personal spending, we can hardly expect any upward pressure on both wages and consumer prices. Another form of protection against inflation is offered by the strong Canadian dollar. The Looney rebounded from the March lows near $1.30 against the greenback, to about $1.05 at present, keeping the prices of imported goods down.

Year-to-year inflation is definitely increasing, not likely to dip below zero again. The Bank of Canada’s target rate for core inflation is 2%. The core rate coming in at 1.8% for October came quite close to this limit, but for now the Bank is more concerned with stimulus efforts, than inflation, providing assurances that interest rates will remain around 0.25% until at least June 2010. Month-to-month inflation is steady, and with the government stimulus having only a mild effect, the threat of rapid inflation growth in the upcoming months is not likely.

We have to be careful, though, to not underestimate the situation. The cushion that oil prices have been exerting on inflation will soon disappear, and will begin to have the reverse effect. Extremely low interest rates will continue to fuel some markets (especially the housing market) and the economy will start growing again, sooner rather than later. Finally, the billions of dollars injected into the economy (no matter how small this amount was compared to our southern neighbour), is trouble-in-waiting (in the form of higher inflation), if the economy does start to gain strength. It appears that we may be backed by a strong Looney against the U.S. dollar for the near future, but we shouldn’t rely on this as our only shield against inflation.

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