Could inflationary pressure pick up?

At 0.6%, the increase in the U.S. consumer price index (CPI) in July was about twice what economists expected. In a report on Thursday, CIBC Economics considered the factors affecting stronger U.S. inflation and provided an inflation forecast.

CIBC noted that the recent increase in U.S. prices was the result of more than rebounding prices in clothing, air fare and car insurance following the economic shutdown.

“Prices even outside of these areas were, on average, firmer than the trends seen over the spring,” the report said.

The increase was due mostly to service industries where social distancing requirements keep capacity low and/or result in higher costs being passed on to consumers, CIBC said.

For example, restaurant prices have increased, as have prices for personal services such as haircuts.

The annual inflation rate in service industries could remain elevated until at least summer 2021, the report said, unless a vaccine lifts the supply constraints resulting from social distancing.

At the same time, a large output gap and high unemployment rate may have a dampening effect on price increases. (The output gap is the difference between actual and potential GDP.)

Given that both supply and demand have fallen significantly in various sectors because of the pandemic, measuring the output gap is difficult, the report explained. However, it noted that strong fiscal and monetary policy responses to the pandemic support consumer demand, at least for services where consumers feel safe to resume spending. Price pressures in those areas will help offset weaker inflation in others, the report said.

At the same time, the end of the Canada Emergency Response Benefit and the Canada Emergency Student Benefit could have a negative impact on household spending, said Desjardins in an outlook report on Thursday. Desjardins forecasted U.S. inflation of 1.8% for 2021.

CIBC said it expects U.S. core CPI to firm further, potentially peaking at about 2.5% in spring 2021. Its outlook is based on higher inflation in those service industries where supply has been constrained, as well as potential pass-through from the weaker U.S. dollar to imported goods prices.

While U.S. inflation is likely to be higher than consensus expectations over the next year, “this is not a stagflation story or a story in which strong monetary support causes runaway inflation,” the CIBC report said.

“Instead it is simply a byproduct of the big changes in supply and demand seen during this unusual time, particularly within service industries where close contact with the customer is required.”

If a vaccine emerges, inflation could eventually trend lower in a couple years.

“There would therefore be little pressure on policymakers to raise interest rates until that final, post-vaccine stretch of the recovery is well underway,” the CIBC report said.

CIBC also said Canada could start to catch up to the U.S. in the second half of 2020 in terms of inflation — the Canadian economy reopened later. Yet, differences in inflation between the two countries also reflect calculation differences, the report said.

Desjardins’ inflation rate forecast for Canada was 0.7% for 2020 and 2.1% for 2021.

For full details, read the reports from CIBC Economics and Desjardins, the latter of which lists major economic and financial indicators.