While inflation in recent months has proved more than transitory, its persistence in no way portends a return to the inflation of the ’70s and ’80s, a CIBC Capital Markets report argued on Thursday.
The report outlined several puzzle pieces that together align for a tame inflation outlook in 2023. Among them was slower expected growth in North America next year — “sufficient to get inflation under control,” the report said. CIBC forecasts Canada’s real GDP growth to be 3.8% this year and 2.2% next; and in the U.S., GDP growth of 2.7% and 2.1%, respectively, is expected.
Still, taming the inflation beast will require central bank skill. To that end, a positive factor for the Bank of Canada is that cyclical inflation, as reflected in the rising prices of many household goods and services, is what’s particularly high, and that type of inflation is what monetary policy should be effective at targeting.
“[A]t least some part of the run-up in inflation [i.e., the cyclical part] should ease as interest rates are raised and the economy slows,” the report said.
And as far as taming the housing-related component of inflation, the central bank should have more power than normal. That’s because shelter components of inflation, which are typically non-cyclical, have more fully reflected the pickup in Canadian house prices than they did in prior inflation peaks.
As a result, when the central bank raises rates, “we expect the housing market to cool rapidly and the pressure on the prices of these components to abate,” the report said.
It also noted that, unlike in the ’70s, wages aren’t keeping up with price increases, so “a squeeze on purchasing power” will act as a brake on inflation.
“[H]igher prices could be an earlier part of the cure for higher prices, suppressing demand and requiring less of a bludgeon from monetary policy,” the report said.
Further — and crucially — inflation expectations are so far in check after decades of stable prices (the expectation of inflation fuels more inflation). In contrast, inflation in the ’70s comprised several waves dating back to the late ’60s, requiring the ’80s recession and long period of economic slack to unwind expectations.
While financial markets won’t receive any calming signals about inflation soon easing given such things as still-rising gas prices, food supply concerns arising from the Ukraine invasion and Covid lockdowns in China, a return to the central bank’s target is in view, the report concluded.
“[A] return to neutral interest rates, slowing economic growth to something close to or a bit under its long-run trend, should be good enough to return inflation back to the [central bank’s] 2% target by 2023.”