Canada will lag the U.S. in post-pandemic recovery, this economist says

Canada’s inflation rate was an eye-opener this past month when it hit 3.6 per cent in May, but it’s our neighbours in the United States who are likely to see the biggest post-pandemic jump, says Benjamin Tal, deputy chief economist at CIBC, who projects a faster economic rebound in the US will make for higher inflation as well.

“Our sensitivity to higher interest rates is more than double what you see in the US, which means that when interest rates start rising, the impact in Canada will be much more significant in slowing down the economy and the consumer than in the US,” said Tal, speaking on BNN Bloomberg on Tuesday. “That sensitivity … is extremely important, and therefore, the US economy will outpace us at the same time inflation there will be stronger.”

Statistics Canada reported last week that the Consumer Price Index rose 3.6 per cent in May and up from 3.4 per cent for the month of April, making for a 2.5-per-cent year-over-year gain and putting inflation at its highest pace in a decade. Stats Canada chalked up the increase to rising prices for things like shelter and vehicles, where shelter costs increased by 4.2 per cent and transportation rose by 7.6 per cent. Prices for durable goods rose 4.4 per cent, which was the fastest pace dating back to 1989, while the price of gasoline continued to climb, albeit at a slower rate. Gas prices rose by 43.4 per cent year-over-year in May compared to a whopping 62.5 per cent in April.

Those numbers taken in the broader context may not loom so large, however, considering the economic lows of 12 months ago. The US, by comparison, saw inflation grow at a five-per-cent clip in May.

Tal said relatively fewer severe lockdowns in the United States compared to Canada over the course of the pandemic has given the US a jump over Canada in the recovery. And with Canada’s economy being more responsive to key interest rate adjustments than the US, the Bank of Canada is likely to be more careful on raising rates.

“Since the beginning of this crisis the US was much more open than Canada, about 20 per cent more open, which means that economically speaking, they did better, and so we have to work faster to stay in the same place because we are starting from behind,” Tal said.

“That’s one reason why we believe the US will expand and move faster than us in terms of overall economic growth and therefore inflation,” he said.

Tal said the market seems to be pricing in a stronger move by Canada’s central bank in terms of raising interest rates than is expected in the United States but in fact less dramatic rate hikes are likely to be the case.

“The Bank of Canada will be much more powerful, if you wish, than the [US Federal Reserve] when interest rates start rising because the effectiveness of higher interest rates will be much more significant [in Canada],” Tal said.

“The US also sits on a mountain of excess cash, so that’s really not a difference between Canada and the US. The difference is in the debt situation, and that’s where you see the sensitivity, and therefore, you will expect with inflation in the US outpacing inflation in Canada and economic growth in the US outpacing economic growth in Canada you will expect the market to expect that the interest rates in Canada will be moving more slowly than the US,” he said.

“You look at the expectations from the market and what do you see? The opposite — the market is expecting not only the Bank of Canada to move early but also that the Bank of Canada will be more aggressive in terms of the overall tightening,” Tal said. “That doesn’t make any sense to me, quite frankly. With less inflation in Canada, slower growth and closing the output gap you will expect actually the Bank of Canada to be less aggressive, and that’s the opposite of what the market is telling us.”

Responding to the inflation rise in May, the Bank of Canada has stayed the course and reiterated its earlier claim that currently ultra-low interest rates won’t be touched for at least the rest of 2021 and probably into 2022.

Deputy Governor Tim Lane said the rise in inflation shouldn’t be a worry, while noting that with vaccination rates rising across the country the Canadian economy should do well going forward as indicated by the economic growth seen south of the border.

“These base-year effects are, by definition, transitory — they will not persist beyond the next few months,” said Lane in a speech last Wednesday. “What will persist until we see a complete recovery is the underlying slack in the economy. This slack will continue to put downward pressure on inflation as these base-year effects fade.”