Inflation's out there – you can smell it and taste it.
And you can feel it, right in the wallet. A new estimate by CIBC World Markets says rising energy prices could cost almost $950 per household this year, or $12-billion in total. No one's yet estimated how much higher food prices will cost families, but it's not chump change.
It sounds like inflation is starting to eat us up, but don't expect to see any sign of this when the Bank of Canada shares its thinking on interest rates and the economy on Tuesday. The kind of inflation we're seeing isn't what scares central bankers. For that, we need strong economic growth and a strong move higher in wages.
The inflation numbers for families are a different story. CIBC economist Benjamin Tal estimates that spending on gasoline as a share of disposable income is less than half a percentage point shy of the 2008 peak. Low-income families are feeling the worst of it because they spend twice as much of their income on energy as families with high incomes.
As for the price of food and other goods, George Weston Ltd. recently said it will increase the prices of its baked goods by an average 5 per cent as a result of higher costs on raw ingredients such as sugar, wheat and oil. And in its latest quarterly business study, the Bank of Canada itself found a significant increase in the inflation expectations of corporate executives.
Many people wonder why, amid all these prices increases, the headline inflation rate tracked by Statistics Canada remains at yawn-inducing levels around 2 per cent.
Statistics Canada analyzes inflation using a basket of goods and services that weights purchases according to how influential they are in your household spending. Transportation and food together account for just more than a third of the consumer price index.
Anyway, as much as food and gas price increases can bite, they're not top of mind at the Bank of Canada. In a way, that's a good thing because a central bank that is worried about inflation is a central bank that is cranking up interest rates fast and hard.
Why Core Inflation Matters
In tracking inflation, the Bank of Canada watches what is known as the core rate. It's distinct from the headline rate in that it excludes such volatile categories as fruit, vegetables and gasoline. "When you take out some of these categories, there isn't much inflation in Canada," said Emanuella Enenajor, another economist at CIBC World Markets.
Why ignore categories that happen to account for most visible inflation right now? Part of the reason is that they're highly volatile and liable to distort inflation numbers over a short period of time. Food and energy inflation are also subject to factors outside Canada. Remember, the Bank of Canada's key concern is what's happening in our economy.
For example, the central bank pays a lot of attention to economic growth, which has been better than expected. Is that inflationary? Not so much. A high dollar is actually cutting the cost of imports, and wage increases are running at modest levels around 2.2 per cent.
An inflation worry looking ahead is that soaring commodity prices –oil, corn, wheat and such – will fuel a broader rise in prices or stoke demand for higher wages. But economists say that with unemployment still at elevated levels following the recession, it's not likely that wages will rise a lot.
Inflation Will Cool Off
None of this will be of any comfort if your family finances are stretched painfully by higher gas and grocery costs. But here's something that may help: It could be that inflation will actually decline in the next 12 months.
U.S. Federal Reserve chairman Ben Bernanke has said the recent runup in inflation in the United States will pass. At CIBC World Markets, they take a similar view. Ms. Enenajor said the firm sees energy prices declining later this year and thereby helping to push the headline inflation rate to 1.8 per cent next year from a projected 2.5 per cent in 2011.
Note that core inflation – that with some of those nasty food and energy categories removed – is forecast to rise over that same timeframe to 2 per cent from 1.6 per cent.
This helps explain why interest rates are projected to rise, even as inflation remains under control. Ms. Enenajor said the central bank wants to keep a rein on inflation, but more importantly it wants to normalize rates after the historic lows reached during the recession.
The one small positive here for families is that things could be worse. If inflation were to be rampant in the broad economy, we could have both higher prices and much higher interest rates.
2%:Bank of Canada's target rate
0.9%: February's core inflation rate (the rate the central bank focuses on; it excludes energy and food, both volatile)
2.2%: Headline inflation rate in February (this a secondary rate to the central bank, but it's all-inclusive)
15.7%: Increase in gasoline prices in February
2.1%: February rise in food prices
-2%: Decrease in clothing and footwear prices in February