Inflation continues to be no problem in either the United States or Canada. In fact, what is taking place is exactly what one would expect. There is convergence occurring between all-items year-over-year prices and core inflation rates. That is because world commodity prices – especially the global price of oil – were at their peak in July of last year. They started to fall after that, all the way through February of this year, and therefore year-over-year comparisons, simply due to the mathematical calculation, will gradually ease.

For example, a month ago in July, the year-over-year energy sub-component index of the CPI was -28.1% in the U.S. and -23.4% in Canada. In the latest report for August, those numbers have fallen back to -23.0% in the U.S. and -19.1% in Canada. This process of easing will continue for many months. In an inverse way, it will exert an upward bias on the year-over-year all-items indices for both countries. This is good news. Deflation is not desirable. It makes loan pay-backs harder and it plays havoc with interest rate policy.

Too Much Excess Capacity in the System

At the same time, it needs saying that there will be no reason to expect overblown upward pressure on prices either, until at least well into next year. There is just too much excess capacity in the economy. Capacity utilization rates in manufacturing and industry generally are at or new historical lows. And there is a big overhang in labor markets, with unemployment hovering near 9% and maybe about to rise to 10% in the U.S.

A major consequence is that the current era of low central-bank interest rates is not in any danger as yet. The Bank of Canada has promised to keep its target overnight interest rate at 0.25% through June of next year. The BoC will have an incentive to keep interest rates low in Canada even if they start to rise elsewhere. It will be a means to take upward pressure off the Canadian dollar, which is bound to occur as raw material prices rise.

All Bets are Off Longer-term

Longer-term, all bets are off with respect to inflation. There are two primary causes which may make it become a problem again. First is the boost that will be given to commodity prices once China, Southeast Asia and India really get back into the economic swing of things. Second is the massive stimulus that has been provided by many governments to their local economies to free them from recession. This has meant increases in the money supply that will eventually find expression in bidding up asset values. It’s not known yet which assets those will be – stocks, commodities, homes, etc.?