Inflation goes down but prices will not go down. Here’s why

Inflation is declining. Statistics Canada reported this week that the annual rate came in at seven percent in August. That’s down from the four-decade high we saw in June.

But this does not mean that prices are going down. Even the most optimistic scenario predicts prices will continue to rise even as inflation is brought back under control. “It’s more that price increases will be slower than prices will fall,” says Benjamin Ritzes, chief economist at BMO.

The best case scenario is that higher interest rates, and a cold economy, will bring inflation down to a more moderate pace. At the moment, overall inflation is slowing – but it is declining mostly due to lower global oil prices.

Reitzes says consumers should not expect this to happen with other goods and services.

The cost of dining out has risen since 2020. Even as inflation eases, analysts expect prices at restaurants to continue to rise. (Daniel Nierman/CBC)

“It’s possible that some prices will come down, like we’ve seen gasoline prices go down,” he says. “But others are at a new, higher level and they will increase at a slower pace and that is the slower inflation.”

More interest rate increases are expected

As higher interest rates increase borrowing costs and affect economic growth, some of the biggest and oldest drivers of inflation are back in the ground. Oil has fallen sharply this year, shipping costs are almost back to what they were before the pandemic and the price of major grains and corn has also fallen.

But the cost of food and services is still going up. Food prices rose 9.8 percent in the year to August. The fight will continue to lower prices. Economists expect that the Bank of Canada will go ahead with its plan to raise interest rates further.

“It is possible that inflation has not slowed down much enough, or long enough, to convince the Bank of Canada that further rate hikes are not necessary,” CIBC economist Andrew Grantham wrote.

This means that Canadians who are already suffering from higher prices will be further pressured by increased debt payments. The economy will slow down and jobs will be lost.

We haven’t seen this kind of inflationary rise in decades, so people forget how dangerous it is, says Pedro Antunes, chief economist at the Conference Board of Canada.

He says inflation is eating up our purchasing power. The cost of just about everything is surely going up. But the wages are not aligned. In fact, wages fall when you factor in the increased costs. Real wages are calculated by subtracting wage growth from inflation.

Antunes says the gap between wage gains and price growth is now being instilled into the economy. “We’re going to see that kind of a blow to our ability to buy goods and services.”

Gas prices have fallen in recent months, which has contributed to a slowdown in the rate of inflation. (Shawn Kilpatrick/The Canadian Press)

And although price growth has slowed, it will take a long time to return costs to the window that the Bank of Canada has deemed acceptable.

The central bank would like inflation to grow between one and three percent each year. How quickly inflation returns to that window depends on how aggressively the Bank of Canada raises rates, says RBC economist Claire Fan.

Fan says her forecast shows inflation won’t return to that window until the end of next year.

“That’s what we hope,” she says. But that depends on the Bank of Canada raising interest rates to 4 per cent by December.

But she says Canadians should remember that slower inflation won’t mean a return to what prices were before all this began.

“Seeing a slowdown in the rate of price growth is what we’d all expect, not an outright price drop,” she says.

After all, the alternative to higher prices is much worse.

Deflation risk

The actual fall in prices will lead to a whole new crisis of the economy.

Deflation occurs when prices generally fall and the numbers in the consumer price index, the basket of goods and services, turn negative. Suddenly people stop buying things, the economy shrinks and jobs are lost.

“It puts a lot of pressure on the economy and it also makes it very difficult for central banks to stimulate the economy when they are in a deflationary environment,” Ritz says.

It’s also a hard cycle to break.

“Just look at Japan,” he says.

Statistics Canada reported this week that food prices in Canada rose 9.8 percent in the year to August. (George Fry/Bloomberg)

Japan has been fighting deflation for decades. Many different governments and central bankers have tried almost everything to get out of it.

“They did their best to get out of it,” Ritz says. “Whatever they could do, they did, the government spent a lot of money and the central bank expanded its balance sheet.”

It’s been a generation since Canadians have faced these kinds of questions. Across the country, people are struggling under the weight of rising prices. The cure is higher interest rates, which leaves debt-burdened families even more stressed.

Price growth is slowing down. But last year’s surge has set a new normal. A new level, if we’re lucky, prices will continue to rise from it – only at a more manageable rate.

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