Market Insights: Inflation!

Inflation continues to dominate news headlines in Canada and abroad. The effects of inflation - the rising costs of housing, interest payments, and the cost of goods and services - have been felt by everyone over the past year, but the reasons behind the rising costs may seem somewhat vague. For many, the government and central banks are to blame, but this is only one side to the inflationary cycle we currently find ourselves in. This blog post will attempt to clarify some of details surrounding the rise in inflation and what is being done by central banks and governments to help reduce the impact moving forward.

What is inflation?

Simply put, inflation is the rise of the average price for goods and services. The Bank of Canada relies on observations of changes to the Consumer Price Index (CPI) to track changes in price levels over time with the CPI reflecting a fixed basket of goods and services (link below for CPI details). Inflation, when kept within specific target rates, is a good thing for the economy as it signifies steady growth. The Bank of Canada targets healthy inflation at 1-3% year-over-year. When inflation increases beyond these levels, central banks and governments will look to implement strategies to help reduce this rate back down to target levels. Governments should look to stop injecting cash into the economy by limiting stimulus and central banks increase interest rates to make borrowing less attractive. The reduction in monetary supply and higher cost to borrow will then reduce the amount of money people and corporations have available to invest or purchase with. When done properly, the economy will slow, and prices will begin to fall back in line with targets.

Where we stand with inflation and how this inflationary cycle is different?

June saw Canadian inflation rates hit 8.1%, the highest level since the 1980’s, before cooling slightly through the summer, with the most recent November inflation rate at 6.8% year over year. The difference between the current inflationary increase and previous accounts is that, in the current instance, the source of inflation is coming from multiple contributors. Covid continues to affect the economy as it has had a lasting effect on organizations’ capacity and labour force. Many countries, including China, continue to force lockdowns and restrict workers in an attempt to curb the spread of infections. The tight labour market has been a significant factor, with wage demand increases often being passed on to consumers causing prices to rise. Many industries are still finding it difficult to find permanent staff to meet demands. Government stimulus continues to be closely monitored by oppositions as well as economists, as further stimulus could have a major impact on the effectiveness of tactics being imposed by central banks. Most recently, the federal government announced their “Mini Fall Budget” and drew a lot of criticism for potentially being too stimulus heavy. The war in Ukraine and heavy sanctions imposed by many western nations on Russia has further hindered global supply chains, specifically in the fuel and food sectors. Finally, the resulting pent-up demand from consumers emerging from Covid-19 lockdowns has also cast a shadow on inflation rates by creating massive demand for goods and services. For these reasons, central banks and governments are having a difficult time controlling the runaway inflation.

What are governments and central banks doing to help?

Central banks around the world really have only one strategy, and that is to increase interest rates. Central Banks are looking to increase rates to the point where we see inflation start to fall - but not increase rates to the point where there is a lasting negative effect on the economy - with the end result being a “soft-landing” for the economy. Central Banks, including the Bank of Canada remain hopeful that this will be the result of their tightening monetary policy; however, many economists feel that this is not realistic, and foresee the near-certainty of a global recession. The International Monetary Fund (IMF) has recently criticized many Central Banks including the Bank of Canada, calling for more transparency in communication coming from governing councils surrounding future rate increases. Government spending continues to be closely monitored as any stimulus can drastically impair Central Bank efforts. Many governments are now caught between a rock and a hard place by trying to provide for those most in need while also not adding fuel to the inflationary fire.

Economists are predicting a high likelihood of a global recession next year. Many feel that this will be the only solution to the high inflation currently experience in the global economy. However, there is some consideration that still needs to be given to the strong job markets currently being observed in many developed nations. Because of this, many economists feel that a recession would be relatively short-lived with many companies retaining staff and allowing for a strong recovery.