The only major economic release today was the Canadian Consumer Price Index for April, which declined 0.2 percent from a year ago. The negative headline is bound to generate talk of deflation. Yet, this would be the wrong interpretation of the figures.
The main culprit for the decline was a 24 percent year-over-year drop in energy prices, with gasoline falling by 39 percent). Other sizeable drops included a 9.8 percent decrease in traveller accommodation and a 4.1 percent fall in clothing and footwear. On the other hand, food, was amongst the categories that saw prices rise, up 3.4 percent.
In order to correct for excessive volatility and better gauge underlying price pressures, the Bank of Canada has devised alternative or ‘core’ measures. The three metrics indicate that inflation is in a range of 1.6 to 2.0 percent. The negative headline on the CPI release, while somewhat concerning, is unlikely to persist. It is related to a transitory change in prices in several large categories.
Looking ahead, the economic downturn could lead to a further downward pressure on prices for some products. Consumer spending could prove weak amid elevated unemployment, reduced household income and health risks. This could lead to increased discounting to attract sales. However, a key countervailing force might be the added cost of delivering goods and services to buyers. In the post-lockdown environment with the COVID-19 virus still circulating businesses are likely going to have to incur costs to allow physical distancing and other measures to reduce health risks and increase the trust of consumers. Firms are likely to try to pass along some of these costs to consumers, where possible I think this will most likely happen in essentials, such as food, personal care products, etc.
Overall, I expect the CPI ex-energy measure of inflation to moderate in the coming months, but not turn negative. Declining inflation is not deflation. It is merely disinflation and it will abate as the recovery unfold.
Besides economic data, today the Government of Canada formally launched the Large Employer Emergency Financing Facility. The prime minister announced this last week, but the details of the program were confirmed today. In particularly, the program comes with a number of conditions, including not paying executives more than one million dollars, not doing share buybacks and publishing sustainability performances and goals. Although some will be critical of these requirements, I do not believe they will be significant obstacles for businesses that are in distress. Remember, this program is meant to be the federal government acting as a lender of last resort. One piece of new news was that scope for the government to have warrants for an equity stake of up to 15 percent of the principal. This allows the government to benefit if the company does well during the recovery, which seems fair from a taxpayer perspective. Personally, I think this approach is better than full bailouts or nationalization.
South of the border, the Federal Reserve published this afternoon the minutes from its April 28-29 meeting round. The minutes revealed the Committee members viewed the COVID-19 pandemic as posing considerable risks to the economic outlook. The minutes also highlighted a considerable amount of worry amongst Federal Open Market Committee members that the current downturn could potentially result in long-lasting damage for the US economy.
Economic damage could prove longer lasting should bankruptcies soar or joblessness remains elevated. Pledging to do what they can, while highlighting the limitations to monetary policy, the FOMC urged Congress to respond forcefully and without delay.
In addition to underscoring the loss of skills that long-term unemployment causes, meeting participants were also, worried that fear over future (secondary) outbreaks could discourage businesses from engaging in new endeavors, delay rehiring workers, or reduce capital investment.
Participants were further concerned by the possibility of spillovers from emerging market economies coming under extreme pressure from the COVID-19 outbreak.
The Fed officials expressed worry about the potential stresses that banks could come under should economic conditions worsen. These stresses could be exacerbated by, what the Committee identified as a high level of indebtedness amongst nonfinancial corporations.
The minutes echo the worries that Chair Powell expressed recently in public appearances. During the post-meeting conference, and in a bid to urge Congress to act, Powell spoke of the many Americans who viewed the pre-COVID labour market conditions as “the best in their lifetime,” adding that it is “heartbreaking” to see that progress threatened. It is clear that the Federal Reserve chairman feel that additional fiscal stimulus is called for.
