Peak inflation? Why do some prices go down so quickly

Timber prices have fallen in recent weeks.Jennifer Gutierre/The Globe and Mail

With inflation at multi-decade highs around the world, some of the biggest drivers of consumer price growth have entered a new and welcome phase: their prices are already falling.

Crude oil, wheat and timber are among the many commodities that have fallen in recent weeks. Freight rates on major trade routes are dropping from record levels. Used car prices, which have risen over the past two years, are showing early signs of declining.

Moreover, bond investors’ expectations of inflation are also declining, an indication that Wall Street is increasingly optimistic that massive increases in consumer prices will turn back.

It is an encouraging development for central bankers as they deal with the biggest threat to inflation in decades through rapid increases in interest rates. At the same time, it would be premature to say that inflation has peaked, many financial analysts say, not to mention that central bankers should squeeze the brakes to raise interest rates again.

Inflation remains uncomfortably steep in major economies, with Canada’s annual rate reaching 7.7 percent in May – the highest rate in nearly 40 years. Large price increases are spreading to include more products and services, while business and consumer expectations for short-term inflation – a key determinant in price setting and wage negotiation – are also rising.

In the next stage of the battle, financial analysts expect the Bank of Canada to raise its policy rate by three-quarters of a percentage point next week, to 2.25 percent from the current 1.5 percent.

The central bank and its global peers raise interest rates to curb demand in the economy, but hope to engineer a “soft landing” that tames inflation while avoiding a recession. However, recession fears have gripped global markets in recent weeks as investors are betting that consumer demand will weaken significantly in response to higher interest rates – and hence lower commodity prices.

“It’s undeniable that some of the things that were driving inflation initially were less of an impact,” said Eric Lascelles, chief economist at RBC Global Asset Management. “I must admit, I am in the camp that thinks that the complete taming of inflation is likely to involve stagnation,” he added.

The recent swoon in commodity prices is particularly exciting for crude oil. The price of West Texas Intermediate, the US benchmark, fell below $100 a barrel on Tuesday on recession fears – well below the recent peak above $120.

Wholesale gasoline prices are also dropping, which should shift to retail prices in the coming weeks. Already, the average price of regular unleaded gas in Canada has fallen to less than $2 a liter, after peaking at $2.15 a month ago, according to data from Kalibrate Technologies. Alberta and Ontario reduced fuel taxes in the provinces, which contributed to lower prices at the pumps. (Some economists say these steps will leave more money in people’s pockets, and keep demand hot.)

Gas is the largest contributor to today’s high inflation in Canada. If gas were excluded, the country’s inflation rate would have been 6.3 percent in May.

Doug Porter, chief economist at Bank of Montreal, said the lower gas price could provide “great relief” in July’s inflation reports, which were published in August.

“Of course, this is just the beginning. Oil prices should remain low and other costs will need to be rolled back to provide lasting relief to inflation expectations,” he wrote Tuesday in a client note. “But it’s a huge step in the right direction.”

At points since the beginning of the pandemic, timber prices have exploded as people have done renovations and developers have built more homes. Now, lumber has fallen to a fraction of peak prices as rising interest rates curb demand for real estate, particularly in the massive US market, and because of strong stocks.

“All sawmills are well stocked across North America. Everyone has records,” said Keita Kosman, owner of Madison’s Lumber Reporter, a Vancouver-based trade publication. “Supply is in line with demand, and mills’ ability to respond and adapt is good.”

Policy makers have pinned much of the inflation spike on supply chain disruptions related to the pandemic, which is leading to product shortages, long delivery times and higher freight rates. Recently, these disorders began to recede. Logistics company Flexport Inc. The average container journey leaving Asia to Europe and North America is picking up speed — although it still takes longer than pre-pandemic delivery times.

Freight rates on major shipping routes are down about 40 percent from peak levels last September, but they’re still much more expensive than they were before COVID-19, according to logistics platform Freightos.

Despite the improvements, many economists are hesitant to say that inflation has peaked. RBC’s Mr. Lascelles noted that high inflation has spread to a wide range of products and services, rather than a few major drivers, and that commodity prices could rise again.

Moreover, if inflation begins to subside, it may take some time to return to the target, which is 2 percent for Canada.

“Some of the severe things are gone at the moment, but there is no guarantee that they will continue to decline and that we will return to stabilization quickly,” Mr. Lascelles said.

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