Grappling with cross-border shoppers, a relatively strong dollar and soft consumer demand, retailers have little wiggle room to raise prices.
Inflation isn't the big bad threat it used to be. Because of an unusual confluence of factors – some potentially fleeting and others more permanent – consumers are enjoying unusually muted prices. There's the still-high dollar, which makes cheaper everything Canadians import.
There's the slowing global economy, which has pushed prices for energy and other key commodities into reverse.
And the weak economy at home means consumers aren't buying like they used to, leaving businesses saddled with too much unsold product.
In a report Wednesday, the Organization for Economic Co-operation and Development said inflation has been pushed lower by the weak economy and "heightened" competitive pressures in the retail sector. But it suggested that price increases would begin to creep back up again some time in 2014 as wage gains pick up and the economy gathers steam.
A quick global rebound, a sharply lower dollar, higher interest rates, or some combination of all three, could indeed jolt inflation back to life.
But a host of more structural changes are also reshaping the retail landscape, including the arrival of aggressive U.S. chains such as Target Corp., the growing clout of online retailers and a surge of cross-border shopping, caused by both the high dollar and higher duty-free limits on cross border shopping trips. Indeed, with little or no inflation, the more vexing problem for merchants is disinflation, with perhaps even the threat of some mild deflation around the corner.
WHY INFLATION IS FADING
Economists point to a convergence of factors that has left businesses with little or no pricing power – and consumers with unusual bargaining clout. Canada is importing a deflation from outside the country in the form of lower energy, commodity and food prices. That helped drive volatile headline inflation, on an annual basis, down to 0.4 per cent in April – the slowest pace since 2009 and well below the Bank of Canada's 2-per-cent target mid-point.
"One of the untold stories of the past six months is the extent to which inflation globally has ground lower," explained Douglas Porter, chief economist at Bank of Montreal. "Canada has seen the most extreme move."
Just as important is the weak economy at home, growing well below its full potential: Businesses have too much capacity to produce and sell, and consumers aren't buying.
Then, there's the fading housing boom. Consumers are likely to spend less if they are not buying homes, and their properties are worth less.
THE RETAIL PRICE SQUEEZE
A variety of competitive pressures are driving down many retail prices, including the arrival of U.S. discounter Target and other aggressive U.S. retailers, the proliferation of online sellers and a surge of cross-border shopping. "The biggest factor today relates to the extent of competition and the promotional environment that we're facing," said Jeremy Reitman, chief executive officer at Reitmans (Canada) Ltd., the country's largest specialty women's apparel retailer which has struggled with sliding financial results.
Wynne Powell, chief executive officer of London Drugs Ltd. in Richmond, B.C., said the pressures have forced many retailers to either cut prices or to defer increases. London Drugs, which carries a significant stock of computers and electronics, has grappled with deflation in those segments, he said. Prices have tumbled about 15 per cent in the computer department over the past year, and between 5 and 9 per cent among televisions. "The days of a regular price are long gone in the TV market."
Retailers' pressure to keep a lid on price hikes, or mark down prices more often, is partly prompted by a flood of new discounters, including dollar stores, U.S. giant Target, which opened its first stores in March, and Wal-Mart Canada Corp.'s expansion here.
THE DISINFLATION PUZZLE
Canada's bout of disinflation leaves Ian Pollick, fixed income strategist at RBC Dominion Securities, scratching his head. Record low interest rates are no longer driving prices higher, even for the most traditionally rate-sensitive products, including cars, furniture, clothes and restaurant meals. "All those components are falling and it makes absolutely no sense."
Price increases for more than two-thirds of the 28 components that make up the core CPI, which excludes volatile food and energy prices, are now running below the central bank's annual 2-per-cent inflation target. That's the largest breadth of disinflation seen in Canadian since 2000, according to RBC.
"It is surprising that inflation is so weak when the Bank of Canada has been on the accelerator pedal with monetary policy for such a long period of time," said economist Emanuella Enenajor of Canadian Imperial Bank of Commerce.
Lower prices should be a good thing. Everyone likes to pay less for things, after all. But when prices are continually falling consumers hoard their cash because they think things will be cheaper tomorrow. So they spend less, and borrow less, causing the economy to stagnate.
Deflation also hurts debtors, who have borrowed money to buy assets that are now worth less, such as a home or a car. Finally, economies don't adapt well to falling prices because most wages are not tied to the CPI. The result is that wages remain high, leaving companies in a profit squeeze.
The Bank of Canada could choose drop its so-called tightening bias on interest rates in the coming months, taking advantage of the June 1 arrival of new governor Stephen Poloz to change the tone. "The first step is to drop the bias," RBC's Mr. Pollick said.
If that doesn't work, and inflation continues to drift toward zero, the bank could opt to cut interest rates or introduce some non-traditional monetary easing, which is now being used in both the U.S. and Europe.
There is very little the Bank of Canada can do about imported deflation. But a floating currency can be a natural hedge against deflation and a weak economy. A lower dollar would drive exports higher. The dollar has already fallen three cents below par with the U.S. dollar, and some economists are predicting a 90-cent dollar by early next year.