Inflation tops expectations
Stats Canada released their March inflation readings which surprised significantly to the high side. While economists were widely expecting a 2.8% year-over-year increase, the actual increase registered at 3.3%, the highest since mid 2008.
Perhaps more significantly, the increase was widespread and not largely concentrated in the energy component of the Consumer Price Index.
Among the main contributors to the jump in inflation were:
• Gasoline (+18.9%)
• Fresh vegetables (+18.6%)
• Passenger vehicle insurance premiums (+4.7%)
• Food purchased from restaurants (+2.7%)
• Fuel oil and other fuels (+31.3%)
The components that experienced the strongest year-over-year decline were:
• Mortgage interest cost (-2.2%)
• Computer equipment and supplies (-9.9%)
• Video equipment (-10.4%)
• Fresh fruit (-3.1%)
• Natural gas (-2.0%)
The increase was widespread across the country, with Nova Scotia (+3.9%) and Ontario (+3.6%) leading the pack.
It’s worth recalling that Mark Carney recently stated that the Bank of Canada feels that current inflationary pressures represent short term volatility. Yet even the Bank must have been surprised by this CPI reading given that they warned that inflation “could reach 3%” by Q2 2011. We’re well above that currently.
The implications are fairly clear. The Bank of Canada has a stated mandate to keep inflation, “near 2 per cent — the mid-point of a 1 to 3 per cent target range.” With inflation now well above the three percent upper boundary, Carney will no doubt be feeling increasing pressure to continue raising rates with a rate hike now very likely in July unless this reading proves to be a one-time spike.
It also bears watching the actions of the bond market today. It’s very likely that Government of Canada bonds will be under selling pressure, meaning higher interest rates. Keep a close eye on the 5 year BoC bond, upon which fixed interest rates are set. As I’ve noted before, this is the key interest rate that now determines the stability of the housing market.
Will Canada be ‘going Dutch’?
It’s worth recalling the recent Macleans article examining the current commodities boom:
And here is that interesting chart relating to commodities:
It’s also worth considering how the recent moves by the People’s Bank of China to rein in inflation via rate hikes and increased reserve requirements will have on commodity demand.
With the US now likely heading back towards near-recession levels of growth later this year, QE2 set to end this summer (likely only temporarily), and with global growth still tepid and set to slow amid supply chain disruptions following the Japanese earthquake and tsunami, the continued bull market in commodities is far from assured.
What might it all mean for Canada if the commodities bull market comes to an abrupt end? An interesting article in the Globe and Mail pondered this very question. The article highlights a recent research report from MRB Partners, a Montreal-based investment research company. (Hat tip to JD for emailing this to me).
Some key quotes:
“Once the current commodity boom ends the loonie will plunge, the economy will stumble badly, wages will fall and complacent policy makers will find out what happens when there isn’t enough growth to compensate for a lack of fiscal prudence.”
“We are constructive about the prospects for the economy and maintain a positive cyclical outlook on Canadian risk assets…Nonetheless, the euphoria needs to be kept in check. Oil and rocks have masked substantial and rapidly growing imbalances that will prove devastating if not corrected before the next global economic recession….(Investors) should be careful not to dismiss these risks.”
“Ultimately, the Canadian economy will fall of its own weight.”
“Energy and agriculture now account for 34 per cent of exports, up from 13 per cent in the late 1990s. Shipments of consumer goods have plummeted by nearly half, to 17 per cent.”
MRB is not advising clients to sell Canada just yet, even though it regards Canadian bonds, stocks and other assets as overvalued. It does warn that a passive, long-term buy-and-hold strategy is a bad idea. “In fact, investors should progressively lighten their holdings as the commodity boom rolls on, especially once global leading economic indicators weaken materially.”
There’s never anything wrong with exploring the potential risks to the Canadian economy. This report aligns nicely with my own perspective on Canadian assets. I’m not prepared to sell them yet, but I am watching leading global economic indicators (such as those published by the OECD) and keeping a close eye on China for any indication that a hard landing is shaping up.
Ultimately the growth prospects for Canada are excellent in the long term. That doesn’t mean that we won’t experience some major headwinds along the way. More importantly, the Canadian growth story is certainly not new and is far from a secret (as evidenced by the $4.9 billion in Canadian stock purchases made by foreigners in February). This raises the risk that long-term growth prospects are already reflected in current stock valuations, which are far from cheap. As discussed before, when the consensus is bullish on a particular asset, it’s the best time to start considering other options that are not as universally loved.