Wage gains an ominous sign for Canada’s inflation outlook

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Need a good reason why the Bank of Canada simply isn't convinced by the Great Disinflation under way in this country? Take a look at the employee wage numbers.

Yes, consumer price index (CPI) inflation last month ran at an ice-cold 0.4 per cent on a year-over-year basis, the slowest rate since the 2009 recession. Yes, even so-called "core" CPI inflation (a measure that excludes the most volatile components such as food and energy, which is not only a more reliable measure of the underlying inflation trend but is the ultimate guide for Bank of Canada interest rate policy) is a thin 1.1 per cent, dangerously close to the bottom of the bank's inflation target range of 1 to 3 per cent.

And yes, all of this would typically spur the central bank to action to bring inflation back toward the happy middle of its target range – meaning, typically, rate cuts to lend a hand to a clearly sluggish economy.

Yet the central bank continues to indicate that its next rate move, whenever that will be, will most assuredly be up, not down. It sees that there are a host of temporary factors that have kept consumer prices down – most recently a dip in fuel prices – that may not last.

And, perhaps more strikingly, it sees the wage growth.

Statistics Canada reported Wednesday that Canada's average weekly wages rose 3.1 per cent in March from a year earlier, matching the pace of February. Those numbers are the highest since last fall, and coming back to back, they make a solid case that wage inflation is gaining speed in this country, as economic growth picked up in the first quarter.

They also make a case for considerably higher inflation pressures on the horizon, as the increased wage costs get passed along to consumers.

"If [above-inflation wage growth] continues, without being offset by gains in productivity – which, as we know, Canada hasn't had the best record – then yes, eventually it will filter through to prices," said Michael Gregory, senior economist and head of Canadian rates strategy at Bank of Montreal.

"Where you would see it most profoundly is on the services side, where wages are a large component of final prices."

Indeed, when you look at wage inflation and CPI over the past 20 years, when wages go up, CPI routinely follows – typically with a modest lag of anywhere from a couple of months to a couple of quarters. But regardless of the timing, the point is that rising wages eventually translate into rising prices. Not only do producers pass along their costs to consumers, but wage gains in excess of inflation serve to increase consumers' buying power and, by extension, sellers' pricing power.

"It's another very subtle reason why the Bank of Canada … is still cautious," Mr. Gregory said.