Canadian inflation, as measured by the year-over-year change in the Consumer Price Index, was weaker than expected in May. Headline inflation dropped to -0.4% last month after declining -0.2% in April. The main culprit for the negative reading was, once again, energy prices. Despite the recent rebound in crude oil prices and at the pump, energy prices paid by consumers were still 30% lower than a year earlier. Excluding energy, inflation was modest at 1%, just one-half of the Bank of Canada’s target.
Slower inflation is consistent with weak demand, which results in economic slack accumulating. Existence of slack is evidenced by the high rate of unemployment and the low capacity utilization rate. Low energy prices also reflect a hit to demand, but are further weighed down by excess supply globally.
In terms of details, goods prices were 2.3% below year-ago levels, with semi-durable and non-durable goods prices 3.9% and 3.5% lower, respectively. Prices for services are up 1.3% from May 2019.
Clothing and footwear prices were down 5.4%, transportation was down 3.0%, and household products prices were 0.2% lower than in the year prior.
Some categories were pricier than a year ago, with food (+3.1%), health and personal care products (+0.9%), and shelter (1.0%) all becoming dearer. Importantly, prices of the latter two fell in May from the month prior.
Excluding food and energy, Statistics Canada’s measure of core inflation dipped to 0.6%. The Bank of Canada’s three core measures of inflation all drifted lower, and ranged between 1.4% and 1.9% in May.
As I have stressed in the past, the negative headline inflation rate should not be interpreted as a sign of deflation. That would require the CPI ex-energy showing a drop year-over-year, with broad-based product price declines. Instead, what we have is a low inflation environment with numerous relative price changes across products.
The inflation numbers are lower than expected, but they should not trigger any change in monetary policy by the Bank of Canada. Remember that the central bank doesn’t set policy based on inflation today, but rather where the Bank thinks inflation will be 12-18 months down the road. With the economy reopening, the monetary authority will likely expect inflation to be trending towards the 2 percent target in the second half of next year.
After weeks of saying it is too difficult to do a fiscal update, given the economic uncertainty at the moment, Prime Minister Trudeau announced today that the government will deliver a “snapshot” of federal finances on July 8. He suggested that it will not be a multi-year projection. So, I expect we will receive an estimate of the federal deficit and debt burden for fiscal year 2020-21.
The challenge with doing this calculation is the high degree of uncertainty regarding GDP and the utilization of government support programs in 2020. The degree of economic contraction in the second quarter is still a source of debate and the pace of recovery during the reopening is highly uncertain. I expect that the government will take its usual approach and survey private sector forecasters, taking the average as the best guess. The government will have an estimate of the cost of all of their recent programs, but this figure cannot be exact. For example, the use of the wage subsidy by employers has been far less than the government expected. The CERB has been extended, but the government will need an assumption on how many people will drop off the program and return to work in the coming months. So, the “snapshot” will be a best guess.
I suspect the deficit will be greater than the Parliamentary Budget Officer estimate of $252 billion this year and the debt-to-GDP ratio of 48% will be higher because the PBO only took into account government announcements up to April 24. But, the low usage of the wage subsidy might provide an offset. Even if the deficit and debt burden prove higher than the PBO estimate, Canada’s fiscal position is strong enough to pay for the federal government support measures. In fact, from a fiscal standpoint, Canada will still compare favorably amongst advanced economies. Mind you, truth be told, it is quite a low bar.
