These economic ‘wildcards’ might keep inflation higher for longer

Over a six-week period, as part of the ‘Out of Pocket’ series, Global News is examining how inflation is impacting Canadians from coast to coast.

Canadians feeling their dollars stretched between high inflation and a rapid rise in borrowing costs have likely been asking the same question for months now: when will it end?

After a year that saw prices at the gas pump top $2 per litre in some parts of Canada and grocery bills soar as inflation hit highs not seen in 41 years, economists have seemed a bit more optimistic in their forecasts in 2023.

Inflation has been on the “downward slope” for months now, says Armine Yalnizyan, economist and fellow with the Atkinson Foundation.

Annual inflation seemed to peak for this cycle at 8.1 per cent in June of last year, cooling to 6.3 per cent in the December reading, according to Statistics Canada.

The Bank of Canada, which undertook the fastest interest rate hike cycle in its history to tame price pressures this past year, said in January that it expects headline inflation to hit the outer bound of its one-to-three-per cent target by mid-2023 — faster than its outlooks from last year projected.

It’s too soon to say inflation has been tamed, however. The central bank noted in its own forecast that there were caveats to the outlook, with many price pressures remaining strong or prone to sudden swings.

Some items in Canadians’ baskets have held onto their robust pricing pace; food inflation, notably, remains above 10 per cent in the most recent reading.

While prices at the pumps have largely receded from this past summer’s highs, the Bank of Canada flagged that the energy market is particularly volatile and could mess with its outlook.

And still-strong demand for services, a tight labour market and other “wildcards in the mix” are keeping the inflation horizon hazy, Yalnizyan says.

“I’ve never seen the range of opinion on where inflation is headed in my life,” she tells Global News.

“There’s absolutely no consensus on what the future holds. Never have things been more uncertain.”

Here’s what you need to know about where inflation stands today and where prices in your life might be headed.

The inflation that Canada and much of the world experienced through 2022 was not like anything the global economy had seen since the 1970s and ’80s, Yalnizyan explains.

She says rampant inflation was born out of a particularly potent combination: a surge in demand after many COVID-19 pandemic restrictions lifted, global supply chain kinks, and the unexpected hit from Russia’s invasion of Ukraine, to name a few.

These supply shocks made it hard for Canadians to buy new cars, appliances and other electronics and were also behind much of the past summer’s run-up in commodity prices including oil and gas.

“We didn’t go through a regular bout of inflation. We went through an inflationary period the likes of which we haven’t seen in four decades because of a pandemic and then because of a war,” Yalnizyan says.

Since then, however, global supply chains have largely adapted to the new reality, though COVID-19 impacts linger and the Russian war still rages.

Dominique Lapointe, global macro strategist at Manulife, says consumers should be seeing “some improvement” in prices on many goods that were affected by the constraints last year.

“Other items that were constrained by supply, such as cars or furniture, electronics, those prices have also come down quite a bit over the past few months,” he says.

But Yalnizyan says even as these sides of the supply chain show improvement, new disruptions are keeping inflationary pressures higher.

Prices at the grocery store are being affected by bouts of agricultural disease, droughts and other severe weather across the globe, she says. The sudden lifting of COVID-19 restrictions in China late last year has also opened the floodgates to fresh demand for fuel and critical minerals, she adds.

“We’ve got a lot of headwinds that may actually keep prices up above the one-to-three-per cent target in a way that nothing central banks can do will affect.”

Despite some progress on the goods side of inflation, economists who spoke to Global News say there’s more work to be done when it comes to price pressures on services.

“Prices at the restaurant, prices to go on an airplane, prices to travel, personal care services. Those prices are more tied to the labour market and the fact that we’re missing a lot of people working in these industries now, it feeds into the fact that prices are not going to come down as quickly,” Lapointe says.

The rush of people eager to return to in-person services after COVID-19 restrictions lifted was constrained by Canada’s stretched labour force. This pushed up travel and hospitality prices, for example, and made dining out more costly.

Canada’s tight labour market — the country added a robust 150,000 jobs in January as the unemployment rate continues to hover above record lows — also means many Canadians haven’t yet been discouraged from spending, with their income holding steady.

Demand for services is showing early signs of easing, Lapointe notes, as Canadians rein in some of their spending in response to higher interest rates and fears a recession might not be far off. But it hasn’t even been a year since rates started to rise, he notes, and it will still be months before the impact of these higher rates seeps fully into the economy.

As more Canadian homeowners come up to their mortgage renewals, for instance, they’ll be forced to renew at higher rates, eating up more of their household budget and taking away some spending demand from the inflation fuel.

“These elements take time to really have an impact on the economy,” he says.

The labour market is a major piece of “uncertainty” in services inflation, according to Bank of Canada governor Tiff Macklem. He said in a speech last week that high labour costs will be one of the reasons inflation could take longer to ease.

“It’s very difficult to see the price of goods that are coming down be matched by the prices of services coming down because we simply don’t have enough people to provide those services,” notes Yalnizyan.

Concordia University economics professor Moshe Lander says that, to date, wage growth hasn’t been fuelling inflation.

“The inflation that we’ve seen over the last 12 to 18 months has not come from rising wages. It’s come from pretty much everything but rising wages,” he says.

Canadian wages are struggling to keep up with the growing costs for shelter, fresh food and other basic necessities.

Macklem acknowledged in his speech last week that risks appear to be “diminishing” that Canada will see a wage-price spiral, wherein workers bid up wages to keep pace with inflation and businesses raise prices in response, further fuelling inflation.

While average hourly wages were up 4.5 per cent in Canada last month — a slight easing from the pace at the end of 2022 — Lander says the central bank will still be looking for this figure to come down before it declares victory in the inflation fight.

In order for inflation to truly cool off and return to the central bank’s two per cent target, businesses need to lower their prices or reduce the pace of hikes.

With global shipping costs returning to pre-pandemic levels, many businesses are finding these input costs are headed down. But what would encourage them to eventually lower their prices, especially as Canadians get used to paying more?

Yalnizyan says that comes from Canadians deciding they won’t pay the price and either forgoing the purchase or finding a cheaper alternative elsewhere — competition cutting down costs. If Canadians start to feel the bite to their incomes, potentially through job losses, they’ll be more inclined to take up deal-hunting behaviour, she says.

Lander notes that just because global commodity prices might be lower, that doesn’t mean businesses can immediately pivot on their pricing decisions. Contracts with suppliers and contractors are set for months or years at a time, he says, and come up for renewal at regular intervals in the same way a homeowner’s mortgage does.

Renegotiating those lower costs, as well as wages with employees, takes a lot more time than passing along higher costs to consumers, Lander explains.

“Backing that up through the supply chain, through your labour, through your capital owners, through your land owners, that’s really difficult to do. And so, it does take a lot longer for that to happen.”

That economic slowdown that the Bank of Canada is trying to engineer may be close — the central bank’s policymakers signalled last month they’d be ready to pause rate hikes if inflation continues to ease according to its forecast.

But Canada’s economy continues its strong output. The job market has yet to show the cracks many economists expected. And interest rates have yet to meaningfully impact many Canadians who are most sensitive to the rapid hikes from the past year.

“The economy continues to defy expectations,” Lander says.

While some economists had predicted a recession would hit Canada in early 2023, the stronger-than-expected economic figures have led some forecasters to push their calls for a slowdown. Bank of Montreal, for instance, pushed its outlook for a recession to start in the second quarter of 2023, a full quarter later than expected.

But while the economy has held up better than most expected in the early goings of the year, Lapointe says Canada and the rest of the world will not be immune to the co-ordinated rate hikes from a number of central banks globally. Eventually, these moves will bring down economic activity and inflation with it, he says.

“The economy is more resilient than we thought,” Lapointe says.

“We thought maybe the fact that interest rates are so high right now would slow down the global economy faster. But it takes some time, and we expect that this slowdown, it’s still coming.”

— with files from Global News’ Anne Gaviola