Bank of Canada interest rates hurt economy as disinflation lurks

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Disinflation, not inflation, could be the Bank of Canada‘s next worry.

At least that’s what some economists are saying following the latest inflation data from Statistics Canada, who believe the 1.6 per cent hike in the consumer price index in September is more evidence that officials need to put the pedal to the metal where rate cuts are concerned.

Signs of disinflation were all over the report, economist David Rosenberg said, from clothing prices, which fell 4.4 per cent year over year, to telecom prices, down 5.1 per cent. Appliances were down one per cent, vehicle prices fell 1.3 per cent and airfares contracted 4.4 per cent.

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“The list goes on, but there is only so much time in the day,” he said in a note following the release.

The Bank of Canada expressed concern about inflation falling below its target in its summary of deliberations in September. Policymakers said they wanted the economy “to grow at a rate above potential output to begin taking up slack in the economy so that inflation does not fall too much.”

Some also said they were concerned about the “downside risks to inflation, particularly if the economy and labour market weakened further.”

The economy is experiencing “excess supply,” economists and the Bank of Canada said, so prices are falling as demand falls short of what is being produced.

“Continued year-over-year declines in air transport and travel tours are also signposts that weakness in household spending could be impacting pricing power,” Andrew Grantham, an economist at CIBC Capital Markets, said in an email.

Bryan Yu, chief economist at credit union Central 1, said the drop in household appliances and furniture princes point to “discounting by retailers amidst weak demand.”

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Some provinces are in outright deflation by one measure: inflation excluding housing.

That rate rose 0.4 per cent year over year, but Matthieu Arseneau, an economist at National Bank of Canada, said “four provinces are now in deflation based on this measure: Quebec, Manitoba, New Brunswick and Saskatchewan.”

In the Bank of Canada’s most recent Monetary Policy Report (MPR), it forecast annualized gross domestic product growth for the third quarter at 2.8 per cent, but most economists now think it will come in around one per cent to 1.5 per cent.

The central bank also projected inflation of 2.3 per cent in the third quarter and 2.4 per cent in the fourth quarter.

“Regarding the balance of risks for the Bank of Canada, I think downside risks to inflation in 2025 are perhaps larger than they previously thought,” Grantham said.

But Arseneau said the situation hasn’t reached the point where he fears “full-blown” deflation.

“There is now a risk that inflation will evolve below (the Bank of Canada’s) target because of an overly restrictive monetary policy that is limiting growth and causing the labour market to deteriorate too much,” he said in an email.

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Stephen Brown, assistant chief North America economist at Capital Economics Ltd., said, “the economy is unnecessarily weak, and, likewise, unemployment (is) unnecessarily high,” and that is why the Bank of Canada will need to cut interest rates by 50 basis points in both October and December.

The central bank has so far cut rates three times, each by a standard 25 basis points, lowering the rate to 4.25 per cent from its hiking cycle high of five per cent.

Looking at inflation minus, food, energy and rent and mortgage costs, “inflation linked to the strength of the economy is already deep down in the levels that we normally only see in recessions or economic downturns,” Brown said.

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The deceleration was driven by a drop in gasoline prices, which fell year over year by 10.7 per cent, Statistics Canada said on Tuesday. Fuel oil and other types of fuel fell by 22 per cent on a yearly basis. Prices for air transportation also fell by 4.4 per cent compared to September of last year. On a monthly basis, overall CPI declined by 0.4 per cent, after a 0.2 per cent decline the previous month. — Jordan Gowling, Financial Post

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• Today’s data: Canada housing starts and manufacturing sales
• Earnings: Morgan Stanley, Alcoa Corp., Kinder Morgan Inc., United Airlines Holdings Inc., Equifax Inc.