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Deciphering the Inflation Puzzle

Navigating the complexities of taming inflation often feels like trying to grasp a slippery eel. This fall, the struggle to rein in headline inflation is poised to continue.

Reining in headline inflation is no easy feat. To appreciate the challenge facing the Bank of Canada, consider the following:

  • In December 2022, the consumer price index (CPI) stood at 153.1.

  • To keep the annual inflation rate below 3% (the upper limit of the BoC's inflation control range), December's CPI would need to clock in below 157.7.

  • However, the most recent CPI reading, from July, was 158.1.

  • Consequently, the CPI must decline by at least 0.253% (157.7/158.1 - 1) between August and December to dip below 3% in December.

  • Compounded monthly, this would necessitate an average monthly decline of -0.05% over the next five months (from August to December).

Canadian CPI

The likelihood of a string of declines averaging -0.05% seems rather remote, particularly with oil prices embarking on an upward trajectory toward the $90/bbl mark.

Crude oil - WTI price
Crude Oil: WTI Price (Source: Refinitiv Eikon)

As BMO Economics noted, "Crude has surged by over 25% in just two short months and poses a significant challenge to the disinflation narrative. In simplified terms, higher oil prices equate to higher interest rates."

Hence, substantial rate relief in the near term doesn't appear imminent.

More Insights into the Inflation Landscape

In order to reach a 4% inflation rate by December, the CPI would need to rise approximately 0.7% between August and December. When compounded monthly, this translates to a monthly increase of 0.15% for the next five reports. Considering factors such as base effects, steadily climbing wages, and energy prices, it's possible that we may see inflation exceeding 4% within a few months.

If you're yearning for a brighter 2024, there's a silver lining. "The CPI in December 2024 will entirely depend on price changes between December 2023 and December 2024," as stated by StatsCan. In essence, prices could rise or fall significantly between now and December without affecting the December 2024 CPI.

Before the year-end festivities, inflation might take an erratic turn, but as long as it increases by a mere 2% from this December to the next, it matters little what happens this year—rates will decline in 2024.

In mathematical terms, to ensure the CPI stands at 2% by the end of 2024, inflation would need to grow at an average rate of 1.021/12 per month next year. Over a year, this translates to an average monthly growth rate of about 0.17%.

CPI end of 2024

​It's worth noting that the calculations above utilize StatsCan's non-seasonally adjusted data. Typically, seasonally adjusted data isn't employed for calculating a year-over-year index like the CPI, as the year-over-year nature inherently accounts for some seasonality by comparing prices in a given month with prices from the same month in the previous year.

The next installment of "As the Inflation Turns" in Canada is set to air on September 19 when StatsCan releases its CPI report. RBC's projection suggests a 40 bps increase: "We anticipate that the headline CPI will rise to 3.6% year-over-year in August, up from July's 3.2%."

Reach out to me today to discuss how this inflation puzzle impacts your financial planning.


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