Good morning,
The Bank of Canada should be able to slow inflation to three per cent from the current 5.2 per cent relatively easily, but moving it to two per cent from three per cent could prove tougher than policymakers might like, says a new report by a Toronto-Dominion Bank economist.
“We’d argue that the path to get inflation to fall from five per cent to three per cent is easier than from three per cent to two per cent given underlying forces that may keep it from decelerating further,” James Orlando said in an analysis released on March 23.
One to three per cent is the Bank of Canada’s inflation comfort zone, but governor Tiff Macklem has repeatedly said he is determined to drag inflation back to the two per cent target.
Total inflation has been on a downward year-over-year trend. It came in at 5.2 per cent in February, compared with 5.9 per cent in January — and 8.1 per cent in June 2022, which was the highest in four decades.
Nevertheless, Orlando said there are things getting in the way of Macklem’s goal of two per cent, among them “supercore” inflation, the “fly in the ointment that delays the return of price stability.”
United States Federal Reserve chair Jerome Powell coined the term “supercore” inflation to focus on the effects of a narrow slice of services — personal consumption spending minus housing, energy and food — on the all-items consumer price index (CPI). According to Powell, the costs of these types of services that cover everything from haircuts to funerals and burials are most sensitive to changes in wages.
“This may be the most important category for understanding the future evolution of core inflation. Because wages make up the largest cost in delivering these services, the labour market holds the key to understanding inflation in this category” Powell said in a speech on Nov. 30, 2022.
Taking its cue from the Fed chair, TD Economics built its own supercore model. It excludes energy, food and housing but includes services such as air travel, accommodation and personal care — “things that are being driven by wage growth,” Orlando said in an interview.
The economist found his supercore measure is running 1.4 percentage points above the average of the Bank of Canada’s three key core inflation measures. “The impact of rising wages and still apparent pent-up demand for services means that this supercore measure will hang up around four per cent to five per cent through this summer,” Orlando said.
If wages are key, they likely won’t cool the services inflation picture much. Average hourly wages in February increased more than inflation, rising 5.4 per cent year over year, and the unemployment rate was five per cent, just off the all-time low of 4.9 per cent recorded in June 2022 when Statistics Canada registered record high levels of job vacancies.
Orlando warned this could mean that the services measure might not touch the top end of the Bank of Canada’s inflation zone until the end of 2023.
On the positive side, TD’s supercore measure fell to a two per cent pace during the three months to February. Orlando warned that the recent rise in employment — Canada recorded a net gain for December, January and February of 241,000 positions — and the potential for that to fuel demand could derail the trend.
“For the BoC to achieve its goal of price stability, it needs the current upturn in economic momentum to come to a halt,” Orlando said.
The Bank of Canada hasn’t mentioned supercore in its inflation discussions, but it is keeping an eye on the cost of services, which increased 5.3 per cent year over year in February, the same rate as January but down from 5.6 per cent in December.
Statistics Canada’s inflation services measure differs from TD’s supercore model in that the latter excludes sectors that are subsidized, with daycare being one example of where prices are falling because of non-market factors, Orlando said.
