On the up-and-up

Canadian CPI data for May, released by Statistics Canada this morning, suggest that the Bank of Canada is going to face some interesting policy decisions in the coming months.  Headline CPI rose 2.4 percent year-on-year in the month, up from a 2.0 percent increase in April.  All eight sub-components of the index were higher in the month, but the key driver of the increase in the headline figure was a leap in food prices, largely the result of supply issues.  Gasoline prices fell in the month: if that important commodity is excluded, the year-on-year increase in CPI stands at 2.7 percent.

In looking ahead, it's worth focusing on the food and energy components of the index.  If, as StatsCan suggests, the rise in food prices was caused by weather-related supply issues, it is reasonable to expect some pullback in the next few months.  What about gasoline?  The roller coaster ride of headline CPI over the past year has been heavily influenced by gas prices, which rose very sharply in  mid-2018, but have since fallen back.  For now gas prices across Canada remain stable, and so will likely act as a restraint on headline CPI for June.  However, if tensions continue to ratchet up in the Middle East, it would not take very long for the impact to be felt at the consumer level in Canada. 

The Bank of Canada's core inflation measures show a somewhat more subdued picture.  One of the three measures -- 'CPI common" -- has remained unchanged at 1.8 percent for the past few months, but the other two are moving higher.  If we follow the usual practice of averaging the three measures, we find a mean of 2.1 percent in May, up from 1.9 percent in April.  This is hardly an inflationary breakout, but it will certainly have the Bank's attention.

From a policy standpoint, today's numbers are unhelpful for the Bank.  Although it is convinced that the "slow patch" in the economy is ending, the data, apart from employment, have yet to fully bear this out. It would be an exaggeration to exhume the old term "stagflation" to describe the current state of the Canadian economy, but a combination of slow growth and rising inflation is not an easy one for policy-makers to handle.

What makes the Bank's task more problematic is that the rate outlook for the United States seems to be in flux.  Both Donald Trump and the equity markets seem to be fearful, for different reasons, of a slowdown in the US economy in 2020, and are looking to the Fed to ease policy in order to prevent such an outcome.  The Fed may not immediately respond, but it's clearly listening.  Any cut in the Fed funds rate in the next few months would leave the Bank of Canada facing a very awkward decision.