Investments

Inflation, a hot topic


Mathieu Giroux

Analyst – Investment at Blue Bridge

After rising 4,1% in August and 4,4% in September 2021, the Canadian Consumer Price Index (CPI) (Statistics Canada) posted an increase of 4,7% for the month of October, a pace of growth unseen in the past 18 years! This particularly high increase is the result of a temporary rebound given that prices in certain sectors were abnormally low last year.

Inflation can be explained by several factors.

The rise in inflation is essentially due to the pandemic, but also the result to the drop in prices observed in 2020 and to the increase in demand in certain sectors. For example, with people forced to stayed at home and not being able to travel, it created significant imbalances between supply and demand for gas causing the price to drop drastically, resulting in near-zero inflation for 2020. Moreover, household spending habits have been modified and many have decided to renovate their house or to equip themselves for outdoor activities, areas where demand has exploded, causing prices to rise.

This severe rise in rates and prices was also caused by the money injected into the system by the Canadian government, which had to react to a critical situation and the total shutdown of the economy. While this emergency measure provided financial support to the general population, it was not without consequences. It led to an increase of the money in circulation, creating a higher demand for goods and services. As such, the increase in cash available for the same amount of goods offered triggered a scarcity effect, leading to higher prices. This government assistance also contributed to an increase in the purchasing power for part of the population, again creating excessive demand for certain products and a rise in prices.

The higher inflation was also largely due to disruptions in the supply chain. The pandemic caused production interruptions, a reduction in the available workforce and the closure of borders, affecting the import and export of goods.

Some sectors have been much more affected than others.

The Consumer Price Index is comprised of eight major components, some of having significantly higher weights than others. For the September report, the three sectors with the largest impact on the calculation of the CPI, namely housing (30.3%), food (16.2%) and transportation (16.0%), all showed a dramatic increase in prices with respective growth rates of 4.8%, 3.8% and 10.1%, exceeding the Bank of Canada’s desired and targeted level of 2%. The closure of borders and the disruption of supply chains have had a major influence on price increases. More and more products are unavailable on the market, at the same time as demand is exploding. The other five main components of the key inflation indicator, namely household current expenditure (14.9%), recreation and education (9.4%), health and personal care (4.7%), clothing and footwear (4.0%), and alcoholic beverages and tobacco products/cannabis (4.8%), contributed less to the price increase. In fact, in addition to a lower weighting, they showed increases varying between 0.6% and 3%, thus remaining within the range of 1-3% inflation per year.

Of course, inflation is not inherently negative, unless it is excessive and unplanned. However, if it is too high and continues to rise, it could become harmful to the economy as purchasing power could be greatly eroded. In conclusion, considering the risk of an economic slowdown and the continued increase in prices, could we be on the verge of a period of stagflation?

To be continued…

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By Blue Bridge,

07/12/2021

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