The world's recovery from the worst downturn since the Depression is losing ground by the day, and the blowback is starting to hurt Canada.
The Canadian inflation reading released Friday marked the latest in a string of worrisome reports, raising concerns about the health of the economic rebound. The consumer price index for July showed an inflation rate of 1.8 per cent, a softer reading than expected by most economists, and a sign there are few pricing pressures amid uneven demand for goods.
The tame inflation report is just the latest signal that the recovery is slowing. Other recent economic indicators showed the first drop in employment this year, a housing market cooling rapidly, and signs that exports are already suffering from weaker demand in the U.S. and Europe going into the second half of the year.
The economic downdraft means Bank of Canada Governor Mark Carney, the only Group of Seven central banker to have raised interest rates since the recession ended, may be forced to soon rejoin his colleagues on the sidelines. Many economists still expect Mr. Carney will raise his benchmark rate a third consecutive time on Sept. 8, to 1 per cent. But most say he could then take a long break to assess the damage from the sputtering U.S. economy and sluggish growth in Europe.
Even with the harmonized sales tax coming into force in Ontario and British Columbia, year-over-year inflation in July accelerated just 0.1 percentage point from the previous month's pace, Statistics Canada said.
The so-called core rate (which strips out tax changes and volatile items such as gasoline) slowed unexpectedly to 1.6 per-cent on an annual basis - leaving it below Mr. Carney's 2-per-cent target and his forecast of 1.8-per-cent core inflation for the entire third quarter.
The U.S. Federal Reserve, meanwhile, is on deflation watch and this month said it will keep the taps of monetary stimulus open rather than backing away from the steps it took to fight the financial crisis, suggesting that it fears the recovery in Canada's No. 1 market has weakened so much that any talk of scaling back emergency support would hurt confidence.
"Given the clear signs of a marked slowdown in the U.S., it would be entirely reasonable for the Bank to take a long hard look at whether they too want to pause," said Doug Porter, deputy chief economist at BMO Nesbitt Burns in Toronto. "If things are soft enough that the Fed had to shift its policy, even if ever so slightly, I think it's pretty reasonable for the Bank to have some second or third thoughts as well about whether it's appropriate to continue [raising rates]" Stocks plunged Thursday after reports showed new claims for U.S. unemployment benefits hit a nine-month high last week and factory production in the mid-Atlantic states slumped to its weakest level in a year. They fell again on Friday, after a top European Central Bank official said the 16-nation euro zone isn't ready for policy makers to start removing stimulus.
Investors will be wary next week, when the U.S. Commerce Department is expected to report that the world's biggest economy grew at a measly 1.4-per-cent pace in the second quarter, worse than the first estimate of 2.4 per cent.
Canadian growth likely slowed to 3 per cent between April and June from 6.1 per cent in the first three months of the year, Mr. Carney has said, stressing that further rate moves will be "weighed carefully" against developments at home and abroad.
Economists predict Canada's second-quarter pace of growth, due for release on Aug. 31, will be closer to 2.5 per cent.
Investors are already less certain of a Sept. 8 rate hike. The Canadian dollar fell by as much as a penny to the lowest level in a month on Friday, and markets tied to expectations for future interest rates put the probability of a September increase at about 50-50.
Jay Myers, president and CEO of Canadian Manufacturers & Exporters, the country's main industrial lobby group, said Friday that business executives across the country are increasingly worried about what will happen to domestic spending as the kick from government spending wears off, since they're already feeling headwinds from the U.S. and overseas.
"I'm hearing more that orders are being cancelled, I'm hearing more that customers are getting later in payment; these are all indicators that we saw in late 2007 and early 2008, pointing to a slowdown," Mr. Myers said. "Unwinding stimulus is going to be a major drag on the economy going forward, and I think the Bank has to be very sensitive about that."