Between A Rock And A Hard Place

It is fairly common knowledge now that Canadian inflation for the month of May was reported yesterday. Of course we saw a re acceleration of inflation in the month – and not by a little bit. There seems to be a lot of mis information around yesterdays report, with a lot of people saying inflation was up by .3% month over month, however, inflation went from 2.7% in April to 2.9% in May – a .2% increase. Expectations were for 2.6%, so that is where a lot of people are getting the .3% increase from. A lot of market activity is not only based on what the number was, but rather what the expectation of the number was. No matter how you slice it though – inflation is going the wrong way. No only did it stop dropping, it also didn’t level out – it went straight up. Not exactly a good sign.

In the inflation report it noted the main drivers of inflation increases were rent, groceries, gasoline, and cell phone bills. But I am sure not a lot of people eat, drive, talk on the phone or live anywhere……. However things like rent were up 8.9%!!! I don’t care if the price of stewing tomatoes dropped .5%, if my rent was up almost 9%, I still cannot afford to live. As we look towards June’s inflation numbers ( to be reported on July 16 ) I see a little more reason to worry. It is complicated to get in to too many details, but the roll off effect will come into play for the June numbers. Basically inflation is always calculated as a rolling 12 month period. In June of 2023 we saw a lot of decreases due to higher interest rates doing their job. However, as the year over year comparison of June 2023 rolls off ( with its big decrease ) it could lead the June 2024 number to be a lot higher – even if it really isn’t higher, it is just higher than it was a year ago. June was also the lowest inflation month in all of 2023. Ironically enough, the inflation in June of 2023 was 2.80%, and we were still raising rates, but now with a 2.9% inflation print everyone thinks we should be lowering rates. Kind of a head scratcher there……

This higher inflation number was my base scenario, and the reason I didn’t think Tiff and Co. should cut rates earlier in June. I wrote a few times about my worry that should a rate cut happen, it would further fuel inflation. Now, I am not suggesting that the rate cut caused the inflation ( obviously since the May inflation data was before the BOC announcement ) , but rather that the rate cut was premature, and we had not yet slayed the inflation dragon. Not enough pain had been felt my the average person yet to announce that the job was done, and we can lower rates. I fully expect inflation to truck a little higher in June, and probably hit that magical, mystical 3% mark. This will put Tiff in a bad spot.

If we continue to see inflation grind higher ( not drastically but a .1% here, and a .1% there ) it is going to give the central bank a migraine. If Tiff reverses his rate cut and raises rates again, then he will lose a massive amount of credibility. How can you cut one month, and then raise 2 months out? It leads people to ask why the cut happened in the first place? I have said it many times, but what the hell, why not repeat it? I don’t think we should have cut rats in June. Inflation was clearly not back at target, nor did we have a 3 month rolling average to show it consistently coming down, smoothing out etc. We had one or two months at best, where it dropped, however that can be seasonal at best. So, if inflation goes up from here, and Tiff raises rates, he will kill whatever remaining credibility the BOC has left ( lets not forget the “rates will remain low for a long time”, and “inflation is transitory”) , and also kill the market hype around rates coming down. Sorry to all those people who now make a living hyping real estate on Tik Tok, but a rate hike will kill demand and no matter how many walks you go on, or how many videos you dance to – people won’t buy it.

However, there is a larger risk in rising inflation, and that is if the BOC DOESN’T hike rates. Yep, if inflation continues to grind up and the BOC doesn’t raise rates, then we risk a lot more problems with the financial system. If rates do not rise and inflation does, it will really start to deteriorate people’s real earnings. It will also start a cycle whereby people think he won’t raise, so they continue to buy without fearing higher borrowing costs – which begets further higher inflation, and round and round we go. The risk here is if inflation rises and we don’t raise rates to stop the bleeding. After this comment people will argue with me because it goes against their self interest of making money, but the truth is the truth.

No matter what Tiff decides to do, he will be between a rock and a hard place if we continue to see inflation creep up. Since March of 2020 we have had inflation in the 1% to 3% range for only 9 months, with 43 months of that period inflation being either below 1%, or above 3%. That means the BOC is achieving their mandate about 17% of the time. Put another way, that means they AREN’T achieving their mandate about 83% of the time. A lot of people will say that COVID threw things for a loop. Sure, but we can’t blame COVID for an 83% failure rate. We cannot blame COVID for not raising rates when we should have. To the day I die, I will never be able to figure out why central bankers did not raise policy rates in early to mid 2021 when it was clear that inflation was out of control. It was not ‘ transitory ‘ like they said. We all knew it, but somehow the smartest people in the central banks didn’t. People who were well paid, and in the BOC’s case – well bonused, to get it right – somehow got it totally wrong. As we reflect back at the errors made on monetary policy we had the ” rates will remain low for a long time ” – strike 1, “inflation is transitory” – strike 2. Will dropping rates before inflation was tamed end up being strike 3 for Uncle Tiff?