Tuesday, July 21, 2009

Canada Believes It Has A Tight Grip On Inflation

In a continuation of central bank confidence, the BoC maintained rates while announcing their inflation outlook in the medium term. The relevant paragraph:

Total CPI inflation declined to -0.3 per cent in June and should trough in the third quarter of this year before returning to the 2 per cent target in the second quarter of 2011 as aggregate supply and demand return to balance. Core inflation held up at 1.9 per cent in the second quarter of 2009. The Bank still expects core inflation to diminish in the second half of this year before gradually returning to 2 per cent in the second quarter of 2011.

We hope that the 2 percent number was arrived at after some careful thought rather than just SWAGging from the CAGR since 1990. However this is part of a pattern that is emerging across central bank reports. Forecasting lower demand, warning of a deflationary spiral and then predicting a return back to inflation normalcy by late 2010 or early 2011, depending on the central bank.

This last step is somewhat troubling. The focus has mostly been on the US in terms of the potential for hyperinflation (and rightly so) but it's important to keep in mind that other countries are also seeing an unprecedented level of currency creation in their system. To believe that every central bank will ease off the pedal and turn the machine into reverse at the right time, strikes us as wishful thinking. It could also be a conincidence that the major banks have roughly the same timeframe for the "inflation bounce"; if it isn't, there could be some serious imbalances over the next few years.

This is a longer term trend to keep an eye on, especially as borrowers start to begin borrowing again.

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