Inflation is slowing but prices are not going to come down. here’s why

The pace of inflation is slowing. The annual rate was 7% in August, Statistics Canada reported this week. That’s down from the four-decade high we saw in June.

But that doesn’t mean prices are falling. Even the most optimistic scenarios predict that prices will continue to rise even if inflation comes back under control. “It’s more that price increases will be slower than prices will fall,” says BMO senior economist Benjamin Reitzes.

At best, higher interest rates and a slowing economy will bring inflation back to a more moderate pace. At present, headline inflation is slowing, but it is mainly being pulled down by the decline in the world price of oil.

Reitzes says consumers shouldn’t expect this to happen with other goods and services.

The cost of restaurant meals has increased since 2020. Even as inflation slows, analysts expect restaurant prices to continue to rise. (Danielle Nerman/CBC)

“Some prices will probably come down, like we’ve seen gasoline prices go down,” he says. “But others are just at a new higher plateau and they’ll just rise at a slower pace and that’s what slower inflation is.”

Further rate hikes expected

As higher interest rates increase borrowing costs and dampen economic growth, some of the main and early drivers of inflation are coming to earth. Oil has fallen precipitously this year, the cost of shipping has almost returned to pre-pandemic levels, and the price of major grains and corn has also fallen.

But the cost of food and services continues to rise. Food prices rose 9.8% in the year to August. The fight to lower prices will rage. Economists expect the Bank of Canada to push ahead with its plan to raise interest rates even further.

“Inflation probably hasn’t slowed far enough, or for long enough, to convince the Bank of Canada that further interest rate hikes are unnecessary,” wrote CIBC economist Andrew Grantham.

This means that Canadians already affected by the rise in prices will be even more affected by the increase in debt repayments. The economy will slow down and jobs will be lost.

Pedro Antunes, chief economist at the Conference Board of Canada, says we haven’t had this kind of inflationary spurt in decades, so people forget how insidious it can be.

He says that inflation devours our purchasing power. Of course, the cost of almost everything goes up. But wages are not keeping up. In fact, wages go down when you factor in rising costs. “Real wages” are calculated by subtracting wage growth from inflation.

Antunes says the gap between wage gains and price growth is now priced into the economy. “We’re going to see this kind of stubborn damage to our ability to purchase goods and services.”

Gasoline prices have fallen in recent months, which has helped to slow the rate of inflation. (Sean Kilpatrick/The Canadian Press)

And even if price growth slows, it will take a long time to get costs back into the window the Bank of Canada has deemed acceptable.

The central bank would like inflation to increase between 1 and 3% every year. Claire Fan, an economist at RBC, says how quickly inflation can return to this window depends on how aggressively the Bank of Canada raises interest rates.

Fan says his forecast shows inflation won’t return to that window until late next year.

“That’s what we’re hoping for,” she said. “But that depends on the Bank of Canada raising rates to four percent by December.”

But she says Canadians need to remember that slowing inflation won’t mean a return to the prices they were at before all this started.

“We all expect a deceleration in the rate of price growth, not an outright decline in prices,” she says.

After all, the alternative to rising prices is much worse.

The dangers of deflation

A real drop in prices would trigger a whole new crisis for the economy.

Deflation occurs when prices fall across the board and the figures for the Consumer Price Index, a basket of goods and services, turn negative. Suddenly people stop buying things, the economy shrinks and jobs are lost.

“It puts a lot of pressure on the economy, it also makes it extremely difficult for central banks to stimulate the economy when you’re in a deflationary environment,” Reitzes said.

It’s also a cycle that’s notoriously hard to break.

“Just look at Japan,” he says.

Food prices in Canada rose 9.8% in the year to August, Statistics Canada reported this week. (George Frey/Bloomberg)

Japan has been struggling with deflation for decades. Different governments and different central bankers have tried just about everything to get by.

“They did their best to get by. Whatever they could do, they did, the government spent a lot of money and the central bank expanded its balance sheet,” Reitzes says.

It has been a generation since Canadians have been confronted with these kinds of questions. People across the country are struggling under the weight of rising prices. The remedy is higher interest rates, which leaves indebted households even more squeezed.

Price growth is slowing. But last year’s surge established a new normal. A new level from which, if we are lucky, prices will continue to rise – just at a more manageable pace.

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