Oil-stained surface obscures reality of inflation in Canada

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Don't be fooled by Canada's slipping consumer prices, which dipped back below disturbingly subdued territory in September. There are clear signs of inflation below the data's oil-stained surface.

Statistics Canada reported Friday that the consumer price index (CPI) slipped 0.2 per cent in September from August, putting the year-over-year CPI inflation rate at 1 per cent, down from 1.3 per cent the previous month, and the lowest rate since June.

The declines, the first in five months, were the latest setback in an inflation trend that has remained stubbornly mired in the bottom end of the Bank of Canada's 1-to-3-per-cent target range, despite two rate cuts this year from the inflation-targeting central bank. A return to the bank's 2-per-cent sweet spot seems as elusive as ever.

Or is it? Scratch the surface a bit on that 1-per-cent September reading, and you find extreme weakness in one pocket – fuel prices – and solid price gains pretty much everywhere else. Consumer prices are very much mirroring the two-speed nature of the Canadian economy, where the energy sector is going in one direction while the bulk of the economy is moving in the other.

The energy segment of CPI slumped 4.4 per cent in September alone, as the price of gasoline tumbled nearly 8 per cent, reflecting renewed weakness in the oil market. On a year-over-year basis, gasoline is down a remarkable 19 per cent, the main driver in the 11-per-cent decline in the overall energy segment.

Without energy, the year-over-year inflation rate for the rest of Statscan's consumer basket is 2.1 per cent. And, indeed, it has hovered at or a little above 2 per cent for more than a year now, even as the oil shock delivered a sustained blow to Canada's overall economic health. Every major segment outside of transportation – which contains gasoline costs – has posted year-over-year inflation well north of the overall CPI reading, with a median reading of 2.5 per cent.

But here's the thing: That energy effect, which has sucked the life out of CPI inflation for months now, will disappear within the next few months. It's all but a statistical certainty. It was last fall that energy prices went into their tailspin, and by January they had bottomed; pretty much from here on in, the year-over-year comparisons in the energy segment are going to look much brighter. Even if energy prices merely held steady at current levels, by January they will be up 7 per cent year over year. This is why the Bank of Canada talks about the oil price effects on inflation as "transitory"; we're about to witness just how transitory over the next few months.

When you break down the data further, it doesn't take long to see healthy inflation numbers almost everywhere outside of the resource-related segments that have been affected by the global slump in commodity prices – a factor that, importantly, has little to do with Canada's underlying domestic economic momentum. (And keep in mind, inflation is a valuable measure to the Bank of Canada and its interest-rate policy precisely because of its ability to reflect economic momentum.)

Inflation in services – which represent 70 per cent of the Canadian economy – was 1.9 per cent in September, up slightly from August, and has hovered near the central bank's 2-per-cent inflation target for most of the year. The goods side tells a very different story, having actually deflated by 0.1 per cent year over year; but even within that segment, there is much healthier inflation once you look past the commodity-intensive goods. Non-durable goods, which are dominated by energy and food, are down 1.4 per cent from a year ago. Durables, which are dominated by bigger-ticket manufactured goods such as cars and household electronics, are up 2.1 per cent. What's more, durable-goods inflation has trended quite dramatically upward since the spring.

Some of this trend in durables is certainly driven by the impact of the slump in the dollar, which has made imported goods and components more expensive. This is why the Bank of Canada has also flagged currency effects as transitory, and continues to try to look through them. (Indeed, the central bank said this week in its quarterly monetary policy report that when it looks at alternative inflation measures to attempt to filter out temporary distortions, it believes the underlying Canadian inflation trend is more like 1.5 to 1.7 per cent.)

However, the loonie effects can't dismiss the solid inflation trend in services, which are overwhelmingly domestic-based and thus aren't currency-sensitive. This is as convincing an indicator as any that once we get past all the noise, there is, indeed, some real inflation bubbling in the Canadian economy – despite September's step backward in overall CPI.