Inflation appears to have displaced global warming as the hottest topic in the news these days. This is probably not a bad thing, since the earth does not seem to be warming as much as some doom-sayers have predicted, while inflation is definitely heating up.

In its recently released World Economic Outlook, the Organisation for Economic Co-operation and Development (OECD) projected that “several quarters of weak growth lie ahead for most OECD countries.” Canada is one of those countries.

The OECD also warned that headline inflation could remain high for some time to come. Reflecting this concern, the OECD revised its 2008 forecast for the Euro Area Consumer Price Index (CPI) to 3.5%, up from its March forecast of 2.5%. In 2009, the OECD expects the CPI to increase by 2.4%, compared to its previous forecast of 2.0%.

In Canada, many might think that we have nothing to worry about, since headline inflation is running at 1.7% and the Bank of Canada’s core inflation rate is still below its 2% target. However, this is hardly the case. Despite the dampening effect of the strong Canadian dollar versus the U.S. dollar on import prices, headline CPI increased by 0.8% in April, its largest month-over-month increase since March 2007.

Since September 2007, year-over-year growth of hourly wages has averaged over 4%.

In its most recent Policy Interest Rate Announcement, the Bank of Canada highlighted this increased risk of inflation. The Bank noted that “if current levels of energy prices persist, total CPI inflation will rise above 3% later this year.”

The Bank supported its June 10 decision to leave interest rates unchanged on its view that “global growth had been stronger and commodity prices had been sharply higher than expected.”

Given this increased focus on inflation and the risk that it will intensify, Reed Construction Data expects the Bank of Canada to leave interest rates at their current level for the next few months, despite increased evidence of slowing economic growth.

Assuming growth stabilizes midway through the second half of the year against a background of persisting inflation, we at Reed think it is likely that, in the fourth quarter, the Bank of Canada will tighten monetary policy by beginning to raise interest rates.

Member Comments