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Canadian Inflation Surprises Markets

23 July 2020 By Mircea Vasiu

The Canadian Consumer Price Index (CPI) took market participants by surprise. The MoM release increased by 0.8%, on expectations of 0.4%, and following 0.3% in the month before.

The surprise came from the steady rise from negative territory two months ago. It comes as an answer to all the efforts put by the Bank of Canada (BOC) that started quantitative easing in response to the coronavirus pandemic.

Inflation Targeting in Canada and the June CPI Release

Almost all banks in developed markets have an inflation-target close to 2%. The level is considered to be far enough from zero (thus avoiding deflation risks) and low enough for the value of money to decline irreparably.

By the time the pandemic hit earlier this year, all central banks had lowered the interest rate level close to the zero boundary. The expectations were that in an economic recession, easing the monetary policy helps inflation from falling.

However this did not work. The magnitude of the declines seen in consumption and the abrupt fall in oil prices made it impossible to stop disinflation and, to some extent, deflation. More was needed, and central banks delivered – they restarted the quantitative easing programs, buying their own government bonds.

The strategy worked once, albeit the Great Financial Crisis in 2008-2009 differed from the current health crisis both in type and in magnitude. Only this time, governments stepped in as well and launched massive fiscal stimulus programs to help alleviate the economic damage and high unemployment rates. This is exactly what BOC and the Canadian government did so far, five months into the pandemic.

From an inflation-based mandate point of view, yesterday’s data is more than good news. It shows economic principles still work even in an unprecedented recession. Moreover, it shows that monetary policy works to the extent that central banks can control the money supply and, implicitly, the value of money.

Another thing to celebrate is the fact that this is the second month in a row when the CPI is above zero and rising. Such a V-shape recovery above the zero level is more than welcomed, and the medium-term positive effects are still to be seen.

The CAD reacted as it should – it rose across the FX dashboard. Moving forward, BOC’s role is to calibrate its tools in such a way to avoid inflation falling again below the zero level, while tempering the steady rise.

Easy to say than done!

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