No Increase in Consumer Prices

A month ago, I noted that if the Core Consumer Price Index remained unchanged from May to June 2007, the annual core-inflation rate would jump to 2.5% because this Index had fallen from May to June 2006. Today’s release from Statistics Canada reveals that this is exactly what happened. Since the monthly Index remained constant at 109.9, the annual rate increase from 2.2% to 2.5% was entirely due to a decline in the base month from 107.5 (May 2006) to 107.2 (June 2006).

The standard Consumer Price Index, which includes energy, declined from 112.1 in May 2007 to 111.9 in June 2007. The corresponding annual inflation rate remained unchanged because prices had also declined between May and June 2006.

On Saturday, The Financial Post reported that core inflation “is expected to climb to 2.5% from 2.2. If correct, the increase in inflation will provide some added justification to the central bank’s controversial decision last week to raise its trend-setting rate by a quarter point and warn that a further, modest increase may be needed to keep inflation from rising above 3%.”

Indeed, at least one chartered-bank economist has already suggested that today’s jump in the core-inflation rate vindicates the Bank of Canada’s decision to raise interest rates. However, I fail to see how a one-month price drop last year warrants higher interest rates in today’s context of stable prices.

Another interesting point is that, to the extent that prices were higher in June 2007 than in June 2006, “the component that contributed the most to the increase was mortgage interest cost, which rose 5.7%” (to quote Statistics Canada.) Mortgage interest costs reflect both the size of mortgages and mortgage interest rates. Chartered banks increased the latter in anticipation of the Bank of Canada raising interest rates. In this sense, the interest-rate hike may have contributed to the inflation it was intended to combat, although the Core Index appropriately excludes mortgage interest costs.

Finally, it is worth reiterating a point made several times before on this blog: almost all of the inflation is in Alberta. Compared to last month’s release, Alberta’s inflation rate rose from 5.0% to 6.3%. Saskatchewan and Manitoba remained above 2%. The other seven provinces all remained below 2%.

The Bank of Canada dismisses criticism that higher interest rates will hurt manufacturers, which are predominantly based in central Canada, by arguing that it cannot concern itself with regional issues. However, the inflation about which it has chosen to obsess is clearly a regional issue.

One comment

  • Excellent points. I stumbled on this site but I will bookmark it. Its funny how many economic analysts missed the base month decline. Statcan even pointed out in their headline that on a monthly basis the core remained unchanged (meaning the movement from 2.2 to 2.5 must have been a result of a decrease in the index last June)

    “The Bank of Canada’s core index rose 2.5%, faster than the 2.2% rise observed in May. On a monthly basis, the all-items index dropped 0.2% while the core index remained unchanged.

    Upward pressure on the mortgage interest cost index is coming almost entirely from housing prices, not mortgage rates. You can look at the new housing price index (also from Statcan) and see the relationship. Mortgage rates are available from CMHC.

    You are right on about Alberta, Saskatchewan and the rest of Canada. Two separate economies.

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