Those darn special factors again

Canada's consumer price index rose significantly faster than expected in July. Data from Statistics Canada show that headline CPI rose 3.7 percent year-over-year, up from a rise of 3,1 percent in June and well above the analysts' consensus expectation of a 3.4 percent gain.  That represents the fastest pace of annual headline inflation since 2011. 

As is usual these days, StatsCan is able to point to a number of one-off or special factors behind the higher-than-expected print. The so-called base effect, notably for gasoline, continues to contribute, though at a slightly lesser pace as the data for the early months of the COVID pandemic fall out of the calculation. CPI excluding gasoline rose a more modest 2.8 percent in July, though it hardly need be said that that is still well above the Bank of Canada's 2 percent target.

Two more novel factors are in play this time. First, the homeowners' replacement cost index, which is how the CPI takes account of the cost of new homes, rose 13.8 percent in the year to July, the fastest pace since 1987.  There are growing signs that the housing market has come off the boil, so this may indeed be a transitory factor. More worrisome is the rise in durable goods prices, which rose 5.0 percent from a year ago, led by prices for passenger autos (reflecting the global semi-conductor shortage, which will not be going away any time soon) and furniture (reflecting new tariffs imposed by Canada on imports from Asia, which are unlikely to be removed). 

The Bank of Canada will be keeping a wary eye on its three preferred measures of inflation, which have been edging higher for some time. Two of the three measures rose in July with one, CPI-trim, moving above 3 percent. The average of these measures now stands just shy of 2.5 percent. 

One-off or special factors are only one-off or special until they're not. The risk for the Bank of Canada is that as the sequence of above-target CPI numbers gets longer, the 2 percent inflation target loses its credibility as a policy anchor.  The COVID pandemic and its after effects are making the data harder to interpret, but there are surely enough worrying signs to keep Governor Tiff Macklem and his team awake at night.