Is Inflation Returning to Canada?

Inflation comes from increases in the cost of labour, materials, production (overhead), shipping, as well as borrowing costs. The last factor is a big part of inflation since interest costs are embedded in practically every product or service created, and this cost must be passed on to consumers via inflation (price increases) or taxes.

The cost of labour has not been a big factor for many years due to stagnant wages and outsourcing of jobs to cheaper locales. Recently, there are movements to raise the minimum wage in many states of the United States and provinces of Canada. These wage increases would mean double digit increases of wages in a short span of time. Many of the lower paying jobs are paying minimum wage, so this effect will be significant. This effect will be tempered by automation and cutting of hours and benefits, but automation will mean large capital costs upfront and if hours are cut, the work has to get done by someone being paid a higher wage eventually. This translates into an inflation “bump” followed by an adjustment period for employers to find ways of regaining profitability after the initial wage shock.

On the materials side, commodity prices have been subdued since 2008, but there are signs that materials prices are coming back up. Energy prices have hit multi-year highs for crude oil. Base metals are beginning to more higher as well as agriculture and foodstuffs. The costs of shipping these goods have also been in the tank for about 10 years but the shipping prices are also making a comeback as evidenced by the Baltic Dry index. The CPI (Consumer Price Index) numbers have risen slightly but are not showing signs of persistence yet. The PPI (Producer Price Index) numbers however, are beginning to make larger increases.

On the interest rate front, the Federal Reserve and Bank of Canada are both raising interest rates slowly. Their actions are relatively benign in themselves, but the bond market sets the longer term interest rates. The 10 year Treasury curve is on an uptrend, which is a sign of higher rates to come as well. Aside from higher consumer debt costs, there is also the issue of higher corporate debt and government debt payments. All of these forms of debt will translate into higher prices for private and public services since virtually every government and large corporation has debt. Government debt translates into higher taxes, and corporate debt used to buy back shares and invest in new capital will translate into higher prices. This may become a self-fulfilling prophecy, as higher debt costs mean higher prices, and higher prices will mean higher input prices for labour and materials, which means higher inflation readings, which means higher interest rates, and so on.

Adding these components together, inflation may be coming back to Canada which will mean a different landscape from the last 10 years. It remains to be seen whether these early signals are a manifestation of a larger trend or a false alarm. There have been indicators in the past pointing to higher inflation that did not materialize.


About joetheinvestor
Joe Barbieri has Bachelors degrees in both Civil Engineering and Commerce from the University of Toronto. He has worked in the Financial Services field for over 12 years, covering positions from Retail Customer Service and Fund Accounting, through to Investment Research on the Institutional side. He has worked in 5 companies, spanning banks, a mutual fund, a Consulting Firm and a Large Canadian Pension Plan. He currently has a Chartered Financial Analyst designation (CFA) from the CFA Institute. He has recently published articles in Pension and Benefits Monitor Magazine as well as the Internet.

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