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It’s welcome news that inflation is easing – at 7% for August, down from 7.6% a month earlier – but what does this mean for interest rates and the Canadian economy overall?

In this episode, Scotiabank’s Chief Economist Jean-François Perrault returns to the podcast to discuss the latest inflation numbers and why interest rates are still expected to rise. While he doesn’t expect a recession ahead for Canada, he says inflation data from September and October are going to be critical and will set the tone for the country’s economy over the next year.

Still trying to get your head around what inflation is in the first place? We have a whole episode dedicated to just that called Inflation 101.

Key moments this episode:
1:10 — Perrault’s take on what a 7% inflation rate means
2:09 — What items contributed most to that rate
3:54 — What’s comforting about the latest StatCan report
4:55 — Why so much was riding on August inflation numbers and why the next few months are crucial
5:47 — Taking a step back and looking at where inflation numbers have been lately
6:24 — Why these numbers actually provide two sources of comfort for experts
7:16 — How do the latest inflation numbers impact interest rate hikes?
9:25 — The Prime Minister’s new inflation relief efforts and its impact. Will that increase inflation?
12:07 — What's next when it comes to inflation numbers?
12:47 — When is inflation going to get back to normal?
13:54 — The r-word: recession. Is that where Canada is headed?
15:22 — Why the hard data might contradict public feeling about a potential recession

 

Transcript:

Stephen Meurice: Seven percent. That was the inflation rate for Canada in August, according to StatCan’s latest report. Still high, but it’s down from the month before. What exactly does that tell us though? Scotiabank Chief Economist Jean-François Perrault is back this episode and he’ll explain what’s behind this latest number and why the next few months are crucial when it comes to tackling inflation.  He’ll also tell us how this might affect interest rates and when we might finally see inflation back to a manageable level. I’m Stephen Meurice and this is Perspectives.

JF, thanks as always for being on the show and I have to ask – have you ever spoken about inflation as much as you have in the last six months?

Jean-François Perrault: Thanks. It's always a pleasure to talk and to answer your question, I don't think anybody's ever talked about inflation as much as they have over the last several months. It is ever present in my world these days.

SM: Well, we’re going to talk about it a little more if you don’t mind. So, as we mentioned in the intro, earlier this week we found out from StatCan the inflation rate — or CPI — for August was 7%. What are Canadians to make of this new number? What are you thinking when you see this?

JFP: Well, listen. First, 7% is crazy high. There was good news in the report earlier this week in that inflation is starting to slow. We've been hoping for that for a while. We were kind of hoping it would happen in August and it seems to happen in August. So, we're somewhat emboldened and call that inflation will decline as the year progresses, but it's important to keep in mind that 7% is still a very, very, very high rate of inflation. So, in terms of relief for households, there is none. It just means that prices are rising a little bit less rapidly than they used to. One of the one of the factors that drove inflation up a lot still in fact, one of the key things in the inflation report was that food prices were, I think, rising at the highest pace since 1981. Inflation CPI basket is a bunch of different things, so you measure prices across a broad range of things. And, of course, food is one of those things that is incredibly important for households. So even though inflation might be slowing a little bit, you're not gonna see it when you go to the grocery store yet. Hopefully we see it as we go forward, but there's still there's still sticker shock out there and there's going to be for a while.

SM:‏ Right, so let's break down that 7% number. So, CPI – that’s the Consumer Price Index, and it’s how StatCan determines inflation — is measured across a broad range of things. You said food prices are rising but what else are the big contributors bumping that number up and is there anything bringing it down?

JFP:‏‏ So, at a very at a very high level, inflation again is a measure of the prices we pay for a broad range of consumer items, consumer goods and services. And it's very influenced by some big, I'm not gonna say big ticket items, but things for which the price moves a lot. Gasoline is the best example of this, and gasoline prices go up a lot. It adds to inflation, so it kicks up the, what we call, total CPI pretty significantly. And we saw that definitely through the summer and through the late spring. Gasoline prices rose a lot. That had a very significant impact on inflation. Those gasoline prices are starting to come down. Actually, they’ve come down fairly significantly in July and August. So, we're seeing that in some of the CPI measures. But that's kind of a normal thing. Oil prices drive CPI a lot. What you tend to do, what we in my business do, we look at CPI excluding things like energy, often excluding food as well because food is another one of the things that's very variable, right? Depends on weather, it depends on all kinds of different things. So, you don't really get a good sense for what underlying inflation is when you look at measures of inflation that include these really volatile food and energy components. So, we look at a measure called core inflation. So, inflation excluding food and energy. The Bank of Canada calculates the special measures of inflation that look at different ways of looking at kind of trend inflation. And those have been obviously less high than those that include oil and gas because oil and gas are so high, but those measures are a better indication of where inflation is likely to go. So, what was comforting about the report we got earlier this week is that we're starting to see, again, maybe starting as a bit of an exaggeration, but certainly the August data pointed to a moderation in these other measures, what we call underlying inflation. So, bit of an optimistic development as far as we're concerned. Because you can't get a sustainable decline in inflation unless you know a broad range of  measures of goods and services normalized or stabilize in terms of their pricing dynamics. So, you got to look beyond the things that we see are most exposed to like you know, we go to the grocery store when we go to the gasoline or the gas station, we see those prices every day. So, we tend to form perspectives on inflation based on what we see there. But you know, they're really important stuff in terms of where inflation goes forward. Is really a function of this broader range of things that we don't necessarily see every day.

SM:‏ Yeah, I was looking at some of the numbers and I read that this was the first month since June 2021 that year-over-year inflation has slowed if you exclude gasoline. So, is that a significant development that could bring a little bit of comfort even though we don’t really know what’s ahead?

JFP: No, exactly. So, I mean I don't want to make too much of one month bit of data. A lot was riding on August. We were hoping for things to turn and it looks like they've turned. And what's even more interesting in August is that we had a positive, we had a good surprise on the inflation side, in the sense that inflation was a little bit weaker than expected. And that is the opposite of what happened with US inflation for August, which you got a couple of weeks ago, where the same dynamic, folks were expecting things to slow because we know that some of these factors that are contributing inflation are slowing. In the US, August date inflation data actually surprised very much to the upside, so it created this angst about what's going to happen in Canadian inflation. Are we gonna replicate what's happening in the US? Do we have control over inflation? Do central banks need to do more? There's a tremendous amount riding on what happens to inflation next few months from a from a monetary policy perspective, from financial market perspective and certainly from a household finance perspective.

SM: Inflation peaked in June at 8.1%. Is that as high as we can expect it to go? Have we topped out?

JFP: Yeah, I think certainly we're hoping that it's peaked and we're on a declining path. Now, a lot of that top line movement because of oil prices, right? So, gasoline prices accelerate, that feeds into inflation. So, we certainly saw that in June where inflation was very high because gasoline prices had accelerated a lot. They've come off since, you're getting this change in inflation dynamics. But we're optimistic about is that we've been hoping for quite a while that inflation would start to turn sometime in the summer, probably late summer. And quite honestly, everybody's forecasting ability for inflation over the last two years has been terrible. We've consistently been under forecasting inflation, inflation consistently come off stronger than we anticipated. And this is the first time, last couple months has been the first time where our view of what's going to happen, inflation is actually kind of materializing. So it gives us comfort not only because inflation is coming down, but we get additional comfort that inflation is behaving as it thought it would. Again, there's a big change from anytime of the last 18 months.

SM:‏ Yeah, even the Bank of Canada I think acknowledged that it maybe had underestimated the inflation risk. So given that, beyond the inflation rate, the other number that all eyes are on is the interest rate. Bank of Canada has been raising rates quite aggressively because that’s their main tool for fighting inflation. Now that we’re seeing these latest inflation numbers, what does that mean for the Bank of Canada? Should we expect another hefty interest rate increase in October?

JFP: So, the Bank of Canada is almost certainly going to do 50 basis points in October. That's our forecast. So, the next meeting is October 26th. The current policy rate is 3.25%. We think they do another 50 basis points and then stop there at 3.75%. This week's inflation report is kind of in line with that because inflation is doing what we were hoping it was going to do. So, this provides a bit more comfort that the Bank of Canada is going to stop at 3.75%. This gives us a bit more comfort that we have a better understanding of inflation dynamics than we did a few months ago. And that's really important because obviously the higher interest rates have to go, the more pain is caused. And, you know, 3.75% is hopefully where things stop and if that happens, I think we avoid a recession. I think we avoid some bad outcomes, but that depends on September inflation to perhaps keep doing what we what we expect it to. And the more we get inflation prints that are confirming this view, the more comfortable we are with, you know, the Bank is gonna stop in October and keep rates there for a fairly significant period of time. The risk is that this decline in inflation is a blip and that we go back to these forecasting errors which we made for a very long time, which is inflation tends to surprise to the upside. Because if we find ourselves in that world where inflation does reaccelerate, that inflation doesn't behave as we think it will, then you're in a world where the Bank of Canada needs to do a lot more, or the Federal Reserve needs to do a lot more. And that's harmful for consumers. It's harmful for business, harmful for the economy. And in addition to the fact that high inflation is in and of itself harmful for households as well, because you pay more for things, you got less purchasing power. So, the August data and September and probably October data are really critical in terms of forming the basis of a view for what happens to the economy in the next 12 months. And this is rare. We don't normally pay this much attention, coming back to the opening question, to inflation. But these are the stakes that are at play. These most recent months on inflation really will have a determinate impact on how the economy evolves over the next 12 to 18 months, whether will be a recession, for instance.

SM: Right, I want to ask you about the prospects of a recession in just a minute, but first, you mentioned households being affected by inflation and the Prime Minister announced last week something that’s aimed at helping with that. A doubling of GST payments for 6 months for low-income Canadians and low-income renters could get an extra $500 top up. Now that’s not implemented yet and this is obviously welcome news to Canadians whose pocketbooks are being pinched from inflation. But doesn’t spending, that kind of spending, make inflation worse? How do you thread that needle?

JFP: So, this is a really tricky thing. It's a tricky thing because the cost of living is a challenge, and we know that there are households that are suffering because of inflation. And governments are there in part to help Canadians when they were they having a hard time. And so it's normal in some sense for governments to look at what's happening, at record high inflation, and try to figure out a way to help households manage that impact on their personal situation. The challenge, though, is that doing so almost certainly will raise inflation, right. When the Bank of Canada is raising interest rates, it's raising interest rates because it believes it needs to slow the pace of economic activity to bring inflation down. When the government then comes in, whether it's the federal government or provincial government, because the provincial governments are doing a lot of things as well. When governments come in and say, listen, we're going to try and lessen the blow. Understandably, right? I mean they've got heart, they’re policymakers. That kind of runs against what the Bank of Canada is trying to do. And what could happen is that as a result of that, the Bank of Canada may need do a little bit more, maybe inflation is stickier. So, while you're trying to help in the short run and you do things to help in the short run, and it's targeted money, so it's the way they're going about it is the right way to give the money to the people that need the most. But even in that situation, you are probably sustaining the period of time which inflation is problematic and probably means that interest rates might be higher, or perhaps higher for longer than otherwise would have been the case. So, it's kind of a damned if you do, damned if you don't situation. I mean, you know, it's one of the reasons central banks are independent because they've got to make these difficult decisions when they set interest rates to achieve 2% inflation in Canada's case. They need to be able to do that in a way that is not overly influenced by political considerations. They need to do the best thing for the economy. And we've decided in Canada that the best thing for us as a country from a macro policy perspective is to achieve low and stable inflation, defined as 2%. If we do that, then we're setting kind of the right economic conditions for Canadians to thrive. And to do that, you need an independent central bank. Because they gotta make those difficult decisions. Politicians are on the other side of that to some extent, though it’s a very difficult and tricky situation right now from a political perspective.

SM:‏ Okay so, what’s next when it comes to the inflation numbers? What do you think we’ll see this time next month and what do you hope we see?

JFP: Hopefully we get a bit of a continuation of what we saw in August, which is inflation continuing to come down, these underlying measures of inflation continuing to show a bit of a deceleration. If that happens again, it will be this very powerful indication that inflation is in fact, behaving as policymakers need it to and want it to. I think that'll be the key thing for us. Another bit of evidence, or not, that inflation is going in the right direction. Because again, if inflation starts to not be going in the right direction, then we need to rethink our interest rate calls. We need to rethink our economic forecasts. So next month is a pretty big deal as well.

SM:‏ Okay so here’s perhaps an impossible question for you — when is all this inflation is going to go back to normal?

JFP: We're some distance away from that. By normal inflation we mean we mean 2%, we mean inflation back to the Bank of Canada's target. That's not likely to happen until early 2024. It's a long ways ahead. And in part, that is a result of some of the drivers of inflation that we see. In part, it's because, you know when central banks move interest rates, it takes a long time to actually have an impact on interest rates. It takes 18 to 24 months. So, what we're doing now in terms of raising interest rates is going to slow inflation over the next few months, but it's gonna have its maximum impact in a year and a half, or two. So that's why we see inflation taking a while to get down. Now, one of the complicating factors is we know, for instance, that wages are going up and they need to go up because wages are below inflation now. So as some of these factors online, as the Bank of Canada tightens policy, we know that wage costs are gonna rise and that's gonna temper the pace of decline in inflation. So, you put all that together, in our mind, it means kind of 2% inflation sometime early 2024, possibly early 2023. But you know not any time soon.

SM: Okay, I want to wrap things up in a minute here. But I have to end by asking about something that you brought up a little earlier which is the r-word — recession. You were on our show back in June saying, “Hey, we probably don’t need to worry about that here in Canada.” Now a lot has happened since then, you still feel that way?

JFP: Yeah, we're still pretty confident about that. Certainly, the inflation data that we got for August are critical to that view. I mean our view has been for quite a while that the main risk of a recession lies in inflation control. So, if we don't have control of inflation, rates have got to go up as I indicated and then that increases the risk of recession. If inflation goes down as it seems, if this is in fact an indication of where inflation is going to go going forward, that reduces the risk of recession quite significantly. And you know that's been the main thing for us. Is inflation gonna go down? If so, reduce your risk of recession. The economy is still reasonably strong, things are gonna slow of course, with central banks raising interest rates, that's designed to slow economic activity as we discussed. But the labour market is still very strong, vacancies are at historical highs. There's a lot to suggest that even if there were to be a recession, so say a negative growth in a quarter, a couple of quarters, that it would be very mild by any kind of historical standard. So it's not something for which we're overly fussed. We think the risk is reasonably low, but even if we're wrong, that the recession itself would be reasonably mild.

SM: Okay, I'm willing to take your word on that. But I feel like if you talked to people on the street right now, for many of them a recession seems like a forgone conclusion. Even economists are divided on that question. So, what’s going on?

JFP: Yeah, I mean, you know, it is like there's no question, this is an environment where people are worried. Whether it's interest rates, whether it's inflation, whether it's wars, whether it's the political situation, Canadians, are worried. We know for instance, there's gonna be a recession in Europe. We know there’s gonna be a global recession. China is almost certainly in recession. Europe is almost certainly gonna be in recession for reasons that are somewhat unrelated to what's happening here. So, we're bombarded by like the world is going to hell in a hand basket. So, people are naturally worried about things. So, when you have kind of surveys of consumer expectations, when you go out and you poll folks, you know, how do you feel about your finances? How do you feel about state of the world? Like it's pretty grim. There's no question about it. The interesting aspect though is when you look at economic data. When you look at the hard data, so not the soft data, we're not really seeing any evidence that that kind of fear that people have is translating into very different spending patterns. And that's pretty important, right? Like you can feel bad about something, but if you're not acting in consequence with that, then those economic fears are somewhat misplaced. A great way to think about that is if people are really worried about a recession, if they're worried about paying their rent, paying their mortgage or they're worried about paying for groceries, there are things that they stop doing. They stop going on trips. That's like the ultimate luxury. You're not going on holiday or take a plane to go somewhere if you're worried about paying your rent. You’re not going to go to the restaurant if you are worried about those things. We know, for instance, on the restaurant side, so if you look at the number of seated diners in Canada those have been increasing dramatically through the year, including recently, like very recently. And that's at odds with, now not obviously every Canadian goes out to the restaurant, of course not. But it's indicative of this split between how people talk about it around the dinner table or parties versus what's actually happening on the ground.

SM: I think we have to leave it there for now. JF, thanks as always for chatting with us today — we really appreciate it.

JFP: Well, thank you, it’s always a pleasure.

SM: I've been speaking with Jean-François Perrault, the Chief Economist at Scotiabank.

By the way, if you’re still trying to get your head around what inflation is in the first place, we have a whole episode dedicated to just that called Inflation 101. You can find that in our feed and we’ll link to it in the show notes and episode page as well. 

You can find that and a transcript for this episode at scotiabank.com/perspectives.

Special thanks to my producer Andrew Norton and my colleague Armina Ligaya, who went above and beyond to make this week’s episode happen.

We’ll see you next time.