©Reuters. FILE PHOTO: People pay for their items at a grocery store in Toronto, Ontario, Canada November 22, 2022. REUTERS/Carlos Osorio/File Photo
By Fergal Smith
TORONTO (Reuters) – As Canadian inflation slows, the cost of essentials like groceries and rent offer clues as to whether they will sustainably return to the Bank of Canada’s 2% target, economists say, as these items are the main drivers of inflation are expectations.
Canada’s December CPI report, due out on Tuesday, is expected to show headline inflation slowing to 6.3% from 6.8% in November, the lowest annual rate since last February.
That’s good news for the economy, but analysts say much of the slowdown will come from energy prices and don’t expect much of an improvement in the annual underlying inflation rate.
Their focus is on the breadth of price increases, as well as more timely three-month rates of core inflation and items in the CPI basket that matter to consumers.
The already decelerated price increases for food and rent as well as for gas are clearly visible and therefore tend to have a significant impact on inflation expectations.
If inflation expectations rise, this could increase wage demands, especially in a tight labor market, which would lead to further price pressures.
“Central banks are getting into this idea that inflation will come down – we know that – but even if it falls below 2%, will it continue?” said Stephen Brown, senior Canada economist at Capital Economics.
“One eye is on wage growth, which is strong right now but not too bad, but then this other idea (which is) on necessities price inflation, which could keep wage demands high as it affects inflation expectations.”
Brown estimates that the CPI trim, one of the BoC’s preferred measures of core inflation, will rise 5.3% yoy in December, matching the pace seen in November.
The Bank of Canada has promised to bring inflation back to target levels by raising its benchmark interest rate to 4.25% at a record pace of 400 basis points in nine months. Money markets see about a 70% chance of gaining another quarter point on a Jan. 25 rate decision.
Food prices rose 10.3% year-on-year in November and housing prices rose 7.2% year-on-year, while the December labor force survey showed average hourly wage growth of 5.1%.
“If inflation slows and wage growth doesn’t, then wages will become more of a tailwind for inflation going forward. This is what central banks are more concerned about right now,” said Nathan Janzen, deputy chief economist at the Royal Bank of Canada.
Still, economists are optimistic that a wage-price spiral, or a prolonged loop of higher wages and prices, can be avoided.
“High inflation is having some impact on wages right now, but whether that’s going to be a problem in the longer term, 2024 and beyond, I think is another question,” Brown said.
“What we really need to see in December is weaker price growth across the board.”
