ANALYSIS: Is the Inflation Wild Ride at an End?

A customer shops for produce at a grocery store In Toronto on Feb. 2, 2024. The Canadian Press/Cole Burston

The latest inflation figures from both Canada and the United States show that inflation has been trending downward after a period of high volatility, due in part to higher interest rates and the restructuring of supply chains.

However, while economists agree that Canadians have seen the end of high inflation for the time being, there is a risk that future geopolitical turmoil could send prices for everyday goods surging higher once again.

“We’re on a good trajectory now. Things are slowing down in the long term. Policy measures that central banks have been employing are working,” said Eric Miller, president and founder of Rideau Potomac Strategy Group.

“But the problem you have is that new things will come along to disrupt this, and it will take time for governments and policymakers to come up with responses to those new measures.”

How We Got Here

Following the COVID-19 pandemic, global inflation skyrocketed as a result of factors such as global supply chain disruptions, increased government stimulus, and higher oil prices due to the Russia-Ukraine War.

Canada saw its inflation rate jump from 2.2 percent in March 2021 to 8.1 percent in June 2022, while the U.S. inflation rate rose from 2.6 percent to 9.1 percent during the same period.

In response, central banks across the world raised interest rates to slow down the inflation. The Bank of Canada increased its benchmark rate from 0.5 percent in March 2022 to 5 percent by June 2023, while the U.S. Federal Reserve raised rates from 0.5 percent in March 2022 to 5.5 percent by July 2023.

Over the summer of 2024, the Bank of Canada implemented two rate cuts in response to falling inflation, lowering its benchmark interest rate from 5 percent to the current 4.5 percent. The latest Consumer Price Index numbers from July shows 2.5 percent inflation, which is the lowest since March 2021.

While the U.S. Federal Reserve has held off from cutting interest rates, even as inflation in the United States fell to 2.9 percent in July, Chair Jerome Powell has signalled that cuts are coming soon.

“The time has come for policy to adjust,” Powell said at the Fed’s annual retreat in Jackson Hole, Wyoming, on Aug. 23, adding that the direction inflation is headed is “clear.”

Reasons Inflation May Have Settled

According to William Huggins, an economics professor at McMaster University, central banks’ “medicine” of raising interest rates worked well at lowering inflation, but the process took a few years to kick in.

While the interest rate hikes seemed aggressive, they were much more lenient than in the 1970s and 1980s, when inflation exceeded 12 percent at some points, he said. The benchmark rate was 4.75 percent from October 1971 until April 1973, when the Bank of Canada began raising it, with the rate eventually hitting over 21 percent in 1981.

Huggins said higher interest rates effectively caused Canadians to cut back on spending, and while the Canadian economy did not technically enter into a recession as defined by two consecutive quarters of negative GDP growth, the country has been in a “shadow recession.”

While Miller agreed that higher interest rates have lowered inflation, he also pointed to the role played by energy prices, supply chains, and China’s changing role in the global economy.

Prices for many items were kept low for over 25 years due to China becoming the centre of global manufacturing, he said. But as China’s economy matured and production shifted to places like Vietnam and Mexico, prices began to rise.

“It was also the fact that we, in North America and elsewhere, have underinvested in our energy infrastructure,” Miller said, adding that Canada has a need for additional oil production and pipeline infrastructure.

Between June 2021 and June 2022, Brent crude prices surged from US$72 to $120, increasing the costs for many manufactured items and foods. “At the end of the day, if you look at agriculture, there’s a hugely significant role that energy costs play,” Miller said.

Geopolitical Risks

Miller also noted several geopolitical risks that could cause inflation in Canada to spike again in the years to come, including possibilities of the United States engaging in tariff battles with other countries.

Huggins said that China remains a large risk factor for global inflation, especially given its aggressions against Taiwan.

He added that the Russia-Ukraine War, tensions between Iran and Israel, and the situation in Venezuela could affect global supply chains and push inflation higher.