Insights and Strategies
Inflation Fever Breaking?
We are now 8-months into the year and it is not surprising that the “inflation fever” is still top of mind for most. While it’s reassuring to see that inflation fever is moderating, albeit from 40-year highs, we believe it is a bit too premature for investors to assume that the return towards more normal levels of inflation will be a smooth descent from the peak. Rather, we expect the path forward will be a volatile one with many ebbs and flows along the way.
As we touched on briefly in our January Insight & Strategies report, we were anticipating inflation to remain elevated and above the long-term trend of 2-3% for longer than most were expecting, with risks to the upside rather than to the downside. Fast forward approximately two months following the release of our January report, and we have a war raging in Europe with the Russian invasion of Ukraine. This unprovoked invasion of a sovereign nation resulted in a slew of global sanctions being imposed on Russia, the Kremlin, President Vladimir Putin, and many close allies to Russia. This, coupled with the continuation of a widely unpopular zero-COVID-19 policy in China, resulted in the exacerbation of ongoing supply chain disruptions that have become a norm since the start of the pandemic. To state the obvious, these two independent events resulted in an upside surprise to inflation expectations which few were expecting, and prompted central bankers globally to act more forcefully with rate hikes.
While we have seen some moderation in inflationary pressures more recently, including in the July Consumer Price Index (“CPI”) report (CPI rose +7.6% year-over-year (“YoY”) versus expectations of +7.6% YoY and versus the June CPI release of +8.1% YoY), the details of the report gave us little comfort to change our outlook on the path of inflation. In particular, the month-over-month decline was primarily driven by a drop in gasoline prices, while several other components of the CPI basket continued their ascent higher including food prices and the prices of services most impacted by the pandemic (incl. hotels, air transportation and restaurants). Since the Bank of Canada (“BoC”) pays particular focus to the core CPI – which excludes volatile components such as energy and food - when it comes to making monetary policy decisions, we expect the continued uptick in the cost of services to keep the BoC anchored in their hiking path into year end. As shown below, markets are currently expecting rates to rise another +1.0% by year-end.