Canadian Inflation Rises To Highest Level Since 2009, Making A Rate Cut Dangerous

Friday, December 20, 2019   /   by Sergey Korostensky

Canadian Inflation Rises To Highest Level Since 2009, Making A Rate Cut Dangerous

Canada’s sky high debt is meeting with higher than expected inflation, and it’s going to be a problem. Statistics Canada (Stat Can) data shows the median consumer price index (CPI-Median) rising in November. The measure of core inflation is now at the highest level in over a decade. By itself, this isn’t much of an issue to worry about. However, due to elevated household debt, the problem analysts have been warning about, is here. The Bank of Canada may have to choose between higher inflation and more debt accumulation, or higher debt costs and lower economic growth.

Median Consumer Price Index (CPI-Median)

Today we’re looking at the median consumer price index (CPI) which is one of the measures of core inflation. It’s calculated using price changes in the 50th percentile, filtering out extreme movements. By excluding outliers, the trend is more in focus. Studies from the U.S. Federal Reserve claim it’s a better prediction of price movements.

CPI-median is different from headline inflation, which is what’s discussed in broadsheets. That stuff, while still important, tends to be more volatile. Consequently, it makes it more difficult to spot trends. Elevated short term spikes in energy one month might skew this index. A drought on another day, might make energy costs more expensive the next. The headline is great for seeing short-term impacts to costs, important in a news context. But it’s too volatile, and requires a lot of trimming and exclusions to extract longer-term trends from.

CPI-Median Hits Highest Level Since 2009

CPI-Median reached the highest levels in over a decade. The rate hit 2.4% in November, up 0.1 points from a month before. This is 26.31% higher than the same month in 2018. The level is actually the highest we’ve seen for CPI-Median since March 2009. Now, this becomes more of a problem for Canada’s credit-driven economy as it gets closer to 3%.

Canadian Median CPI

The measure of core inflation in the 50th percentile of the distribution of price changes. Called CPI-median in Canada.
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Higher Inflation Is A Problem For Credit Growth

Inflation and borrowing rates are closely tied together in modern monetary policy. As inflation falls below target, central banks have incentive to cut overnight rates. By cutting rates, they’re making borrowing cheaper. This increases access to credit, helping to boost economic growth. Higher economic growth, should lead to higher inflation. The bigger the cuts, the higher it rises. They generally do this until they hit the target rate, which is 2 percent in Canada. The closer it is to 3 percent, the less likely they are to cut rates.

When inflation is above the target rate, central banks raise rates to cool borrowing. By making it more expensive to borrow, people borrow less, due to rising servicing costs. Inflation typically responds by falling lower. The higher inflation is above the target rate, the more likely an increase in overnight rates. Inflation typically responds by falling, usually over a six to twelve month period.

The current issue is CPI is trending above target, and marching towards the high end of the range. November’s number is the highest in over a decade, and 20% above the target. The higher this number trends (or remains), the more difficult it would be to cut rates. This becomes more complicated when the inflation pressures are energy and food. In order to bring down those prices, a strong dollar is typically needed. Cutting rates tends to weaken the currency. A problem since fuel is priced in US dollars, and so are a lot of food imports.

The BoC left rates at rock bottom levels for a very long time, inflating household credit growth. Canadian households now have some of the highest debt levels in the world. Consequently, this weighs on the BoC’s decision to cut. Do they send borrowing rates higher to save inflation? Or do they cut, and throw gasoline on the inflation fire? Even if you abstained from Canada’s debt binge, everyone’s debt is now your problem.