Cooler weather will be a relief for many Canadians after a searing summer. That’s a change for us; normally as the sun rises later and later every August day, there’s a pining for an extension of the warm months. We may get that summer extension, but in a place we don’t want it. The mercury has been equally high on the inflation front this summer, and there is little relief in sight as autumn approaches. Is red-hot price growth likely to cool, or are we in for a hot fall?
Last week’s release of U.S. consumer price index (CPI) data was broadly greeted with relief by analysts, cuing up stock markets for yet another rally to record levels. Strange, the comfort that we can get in going from white-hot to “just” red-hot. The annualized July gain rang in at 5.8%, down from June’s whopping 11.4% gain and a three-month average annualized increase of 9.7%. Year-over-year growth is at 5.3%, well above the high end of the Federal Reserve Board’s inflation range—markets are comforted that it didn’t go higher. Even if monthly gains were an annual pace within the Fed’s acceptable range for the rest of the year, annual inflation would still be weighing in at 5.1% in December.
Used car prices soared by 30% from March to June and slowed to a 2.7% blip in July. Sounds good, but July’s paltry increase added to the massive gains that preceded it. True comfort would be a plunge back to more reasonable pre-surge price levels.
Critics will quickly add that core inflation—prices net of food and energy—has a better cooling system. Maybe so, but only marginally. Core U.S. CPI jumped 4% in July, well below the 11.1% gain in June, but still well above the comfort level, and adding to the significant gains to date. Again, cast this forward at better-behaved monthly rates, and you still have year-over-year growth at the 4.4% level by end-year. Yet if the growth rebound continues apace, the exuberant price response will continue.
A further positive message in the July data was the abrupt slowing of prices in sectors that saw out-of-control rises in recent months. Used car prices soared by 30% from March to June and slowed to a 2.7% blip in July. Sounds good, but July’s paltry increase added to the massive gains that preceded it. True comfort would be a plunge back to more reasonable pre-surge price levels. And at the same time, new car prices are rocketing up, by an annualized average of 23% from April through July, with no apparent slowing yet—hardly comforting. Shortages of critical inputs and global shipping constraints argue that price increases well beyond autos are not in for a cooling spell.
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Another worry-factor is wages. Surging job numbers both stateside and in Canada are nudging up average paycheques. It’s not yet enough to warrant heat alerts, but it does speak to the sudden need to bring everyone back at a time when workers particularly the skilled kind—are in short supply.
If this is contained, the worrywarts can sleep more easily. If not, generalized inflation may be harder to rein in. Why? Currently, we’re dealing primarily with demand-push inflation: Too much demand, with supply desperately trying to catch up. It should, after all, we did have enough capacity before the pandemic, and we’re just getting back to overall pre-pandemic gross domestic product (GDP) levels now.
However, if wages join the inflation parade, that’s another story. It’s referred to as a key form of cost-push inflation and is harder to get rid of. Simply put, higher prices trigger greater wage demands, which are generally granted because of the critical need to retain workers. And as worker shortages are generally an economy-wide issue, demands could be widespread. Wages are known to be upwardly flexible and downwardly rigid, so any gains made are almost surely here to stay for a while.
Business is no mere bystander. Higher input costs are putting pressure on margins that in many cases are tied to sales contracts—agreements that were predicated on inflation at roughly 2%. Competitive pressures mean that not only are the internal accountants recommending higher selling prices, shareholders are demanding it, and bank account managers will at the very least be subtly suggesting upping cash flows by increasing the ticket prices of fall sales.
Nobody wants this, but natural forces in our market system are hard to resist—even if it ultimately risks tough central bank medicine. The best remedy is capacity: Enabling full use of existing productive capacity, large amounts of which were idled during the pandemic and creating new capacity—enabling business investment, which during the pandemic has become understandably hesitant. The former is easier than the latter, although both will be needed to get the price thermometer back into the comfort zone. Time is of the essence.
The bottom line?
Words alone won’t work. Wresting current price increases to the ground will be a matter of releasing resources back into the economy in synch with its rebound. If that’s successful in the world’s top economy, the effects are sure to cascade everywhere else. Seems we’re all counting on the Feds to get it right.
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