- Inflation accelerated in line with expectations
- That wasn’t good enough for CAD and shorter term rates
- Key is which measure of core inflation should be relied upon…
- ...as common component remains remarkably stable…
- ...but may be sharply underestimating true core inflation
- Our inflation dashboard
Canadian CPI, m/m / y/y %, October:
Actual: 0.7 / 4.7
Scotia: 0.7 / 4.7
Consensus: 0.7 / 4.7
Prior: 0.2 / 4.4
Canadian core CPI, y/y % change, October:
Average: 2.7 (prior 2.7)
Weighted median: 2.9 (prior 2.9 revised up from 2.8)
Common component: 1.8 (prior 1.8%)
Trimmed mean: 3.3 (prior 3.3% revised down from 3.4)
Canadian inflation continued to climb higher and met expectations. The Canadian dollar depreciated and shorter-term interest rates rallied in the wake. I think there were two reasons for this market reaction. One is positioning in that markets may have been braced for hotter than expected readings which has been the pattern elsewhere (US, UK); perhaps Canada’s consensus was simply more accurate. Second, I’m not sure market participants have the best handle on core inflation and may be over-weighting one measure among 7 that hasn’t budged in many months and that we don’t think is the best gauge. I’ll come back to this issue.
But first, in terms of highlights, average core inflation was unchanged at 2.67% y/y in October using the BoC’s three preferred gauges of trimmed mean CPI, weighted median CPI and common component CPI (chart 1).
Inflation continues to be about far more than just year-ago base effects (chart 2). Month-ago annualized and seasonally adjusted prices have been up by between 6–7% over the past four months and have been running hot since April.
Chart 3 shows the range of all 7 core inflation measures. The lower end of the range arrives with lag (CPI mean standard deviation).
Chart 4 breaks apart the BoC’s three preferred measures of core inflation. Note the historic gap between common component CPI at just 1.8% y/y and the others. This issue deserves focused treatment because a common client question is whether common component’s low reading is the best one.
WHAT ‘CORE’ IS BEST?
CPI-common’s advantage is that it uses a factor-based approach to seeking common price changes across multiple categories of the CPI basket. CPI-common tracks spare capacity conditions best when spending patterns don’t materially change and yet they clearly have during the pandemic with only partial adjustment for this via rebasing that started in July but left all prior months’ weights at 2017 spending patterns. CPI-common is also the most susceptible to year-ago base effects since the other two preferred core measures estimate year-over-year inflation on a compounded monthly weighted basis.
Key, however, is what measure of core inflation should the BoC prefer? We haven’t heard much from them on that topic in quite a while. Our shop’s view is that the BoC should have a preference toward going back to the simple CPI excluding food, energy and indirect taxes measure. See the piece here by René Lalonde and Nikita Perevalov this past summer which they continue to stand by. René and Nikita drew upon analytical efforts to argue that this measure of core is the best one because it is best explained in a Phillips curve framework and has beaten other measures of core inflation at forecasting total inflation by a wide margin over recent years. It would be helpful for the BoC to update its views on which measure(s) of core inflation are preferred given the importance of the matter.
This is not a small issue. If Rene and Nikita are right, then the measure they are pointing to shows core inflation running at 3.8% y/y (chart 5). The rate of change in this core measure on a month-over-month seasonally adjusted and annualized basis is ebbing, but still running hot. That blows common component CPI’s reading of 1.8% y/y right out of the water. That, in turn, suggests that the BoC is perhaps not paying enough attention to the best gauge of underlying core inflation and has confused markets on the topic with too many measures of core inflation. Perhaps that’s by design amid uncertainty…. Nevertheless, if the BoC is internally emphasizing common component CPI to justify its transitory-for-longer than previously expected stance then it may be making policy vulnerable to emphasizing the wrong measure.
OTHER DETAILS
As for broader details, let’s start with a broad decomposition of goods versus services inflation shown in chart 6. Goods inflation accelerated, but only because of food and energy. Services inflation accelerated outright and probably still has further upside ahead.
Chart 7 provides a more detailed breakdown of the CPI basket in terms of weighted contributions to the overall year-over-year inflation rate. Chart 8 does the same thing in unweighted terms. Gasoline is the biggest driver by quite a bit, but homes and vehicles are playing the other biggest roles in driving inflationary pressure. There is substantial breadth to the rest of the gains.
Charts 9 and 10 do the same thing for the month-over-month inflation rates.
Charts 11–17 on the next few pages home in on trends in several specific categories. Homeowners’ replacement cost is a big upside driver (chart 11). Rented accommodation is continuing to heat up (chart 12). Chart 13 shows other housing-related components. Property taxes jumped in month-over-month terms during October as per the norm, but relatively stable in year-over-year terms. Mortgage interest remains a transitory downside that continues to see lower mortgage rates pass through in lagging fashion which is probably something that will turn the other way in 2022. Electricity price inflation was roughly stable.
Restaurant price inflation (chart 14) accelerated at full sit-down restaurants but saw an offset in volatile take-out prices.
Auto price inflation (chart 15) ebbed somewhat in year-over-year terms but remains volatile and is still high.
Airfare prices (chart 16) eased somewhat after the large prior gain but are exceptionally volatile.
The breakdown of the recreation/reading/education category is also offered (chart 17).
Please also see the complete inflation dashboard that breaks down individual components and their changes including mini-charts and Z-scores that depict the size of deviations from norms across individual price changes over 5- and 10-year intervals.
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