Sep 17, 2021

Is High Inflation Here to Stay?

No, your eyes aren’t playing tricks on you. The cost of filling up your car, that new TV and your haircut are much more expensive than they were in previous years. The latest Consumer Price Index (CPI) numbers from Statistics Canada show that inflation in August reached 4.1% (year-over-year) in Canada, the highest level since 2003. In Alberta, the cost of goods and services rose 4.7% last month.

The biggest contributor to recent price increases has been the cost of durable goods. This category includes items like cars, washing machines and refrigerators. According to Statistics Canada, durable goods rose 5.7% in August. Nationally, the cost of vehicles grew by 7.2%, furniture by 8.7% and household appliances by 5.3% in August. The cost of big-ticket items aren’t the only things rapidly rising in price. The cost of services has continued to accelerate for five consecutive months as well. For example, the price for traveller accommodations (hotels, motels, etc.) rose 19.3% across Canada compared to last August.

The main reason for the drastic rise in the price of goods and services over the course of the year has to do with the reopening of businesses. Government mandated shutdowns wreaked havoc and many businesses have since had to increase their prices to stay afloat. Additionally, escalating prices also has to do with an increase in the amount of money circulating in the financial system. This is a result of federal stimulus packages like the Canada Recovery Benefit (CRB) which have helped cushion the blow of COVID-19’s effects.

But, the question on everyone’s minds is whether higher prices are here to stay. According to Jean David Tremblay-Frenette, AIMCo’s Director of Investment Strategy Research, the current trend of inflationary pressure could stay, at least in the short term.

“The current level of inflation will be mostly transitory in nature and ebb over the next year or so. As COVID-impacted factors begin to normalize, so should price increases,” noted Tremblay-Frenette.

Still, there are risks that inflationary pressures could persist a little longer. There are a couple of factors why this might be the case.

Firstly, the rise of the Delta variant. COVID is still the leading risk to future price increases. Especially as we see a continuation of zero-COVID policies in many countries, like China. The longer the COVID pandemic continues, the greater the potential for economic disruption (shutdowns, etc.) If cases get worse or if different, more harmful variants emerge, any type of decline in economic activity as a result of stopping contagion will result in higher prices over a longer timeframe.

The second factor has to do with raw material pricing. Over the first eight months of the year, there have been significant price increases in raw materials such as steel, fertilizer and cement. Such materials have become more expensive due to COVID disrupting trade flows and supply chains. In addition to COVID-related obstructions, raw materials have been subjected to higher carbon pricing and companies related to the extraction of materials to produce steel, fertilizer and cement have had to cut carbon emissions. Together, these things have increased the costs of production and have been passed on to consumers. This is called “cost-push” inflation and the risk of cost-push inflation is growing, especially as global trade continues to surpass pre-pandemic levels.

Still, according to Tremblay-Frenette, inflation escalating out of control is an unlikely prospect. And the risk of continued inflationary pressure may have benefits for markets, too.

“Inflation expectations are expected to gradually rise throughout 2021 and the early part of 2022. As a result, central bank rhetoric has begun preparing for moves to control inflation. But even with a measured exit from extremely accommodative conditions via asset purchase tapering, monetary policy is not anticipated to become materially restrictive in the near term.”

For markets and investors, this means there are some opportunities. “Relatively low interest rates by historical standards should continue to support the hunt for yield and stable income. Private credit, infrastructure and renewable resources stand out as attractive risk-adjusted opportunities in such an environment. Certain real estate sectors can also prove to be appealing, to some degree. Risky assets such as equities would, generally, be expected to continue experiencing sturdy earnings growth in a moderate reflationary environment,” said Tremblay-Frenette.

Even though COVID and its knock-on effects are making gasoline and a new washing machine more expensive, the risk of high prices continuing well into the future is low, for now. The Bank of Canada and other central banks around the world, like the Bank of Canada, have signalled that they will continue to provide the appropriate degree of monetary policy stimulus to support a healthy economic recovery and achieve stable inflation for the long term.

This article contains forward-looking statements with respect to economic conditions. Such statements address future events and conditions, and therefore involve inherent risks and uncertainties. Although AIMCo believes that the expectations and assumptions on which the forward-looking statements are based are reasonable, AIMCo can give no assurance that such statements will prove to be correct. Accordingly, AIMCo disclaims any and all responsibility for the continued truth of such statements at any future date.

This article is of a general nature only and does not purport to take into account all considerations that may be relevant to any particular individual or organization. As such, this article is not intended to be, nor should it be construed to be, investment advice to any particular individual or organization.