It seems that every month there is no shortage of economic activity and changes. As the days continue to tick by, more and more people seem to be realizing that the economic policies of the last two years have caused major cracks in our system. The question remains to be answered if the response is now too little too late.
Will interest rate hikes by many of the world’s central banks really help combat inflation which is most people’s main concern? Will wages keep pace with inflation, or will real wage growth continue to decline?
Rather than just focusing on inflation, we wanted to look at a couple of other noteworthy changes. This includes interest rate hikes, a decrease in real wages, and more stimulus.
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Central Banks Raising Rates
With rising inflation across the world, central banks continue to raise interest rates. Last week, the Bank of Canada raised rates by 100 basis points (1%). That is the largest rate hike in Canada since 1998. It now takes the overnight rate to 2.5%. Rates are up 2.25% in 2022 alone, with many forecasts indicating they could reach 3-3.25% by the end of 2022.
The trend in the US is much the same. Interest rates are currently at 1.75%, with another rate hike likely coming soon. Forecasts show rates to finish out 2022 at around 3.5%. Europe seems to be a little further behind when it comes to raising rates. However, they have indicated their goal is to have rates at 1.25% by March of 2023. They are also reportedly mulling over raising rates by 50 basis points in the near future.
There are many factors at play here and whether these rate hikes come to fruition remains to be seen. If the rate hikes do happen will it be enough to help curb inflation? What happens if central banks raise rates too fast and put the economy into a recession, will they reverse course and start lower rates?
Just to touch on a recession quickly; a widely used definition of a recession is two consecutive quarters of declining GDP. Well, in the US, Q1 2022 saw GDP decrease by 1.4%. Q2 numbers haven’t been released yet, but I am assuming they won’t be pleasant.
Canada and US Inflation
As mentioned already, inflation is the top economic concern for many people. If you want to check out our previous thoughts on inflation check out the following:
As for current inflation statistics, they continue to rise in both Canada and the US. If we are led to believe that raising the interest rates truly made a difference in inflation, it is scary to think what inflation would have been had rates not risen.
Canadian inflation was reported higher again in June. Inflation was reported at 8.1% for June, below the expected 8.4%. In last month’s update, our most very simple projections had inflation for June at 7.85% – 8%. Our projections are based purely on trends.
The biggest increases in June were felt in Gas, energy, non-durable goods, and recreation/education/reading. Interestingly, there was actually a decrease in the cost of semi-durable goods, as well as clothing and footwear. This is not all that surprising as some pundits have been warning about deflationary pressures on certain sectors of consumer goods.
Below you can see both the CPI and inflation statistics since March of 2020.
Canada Inflation Looking Forward
We will continue with the same exercise as we have for the last couple of months presenting two situations; 1) if inflation rises by 0.4% per month for the remainder of 2022, 2) if inflation rises by the preceding 12-month rolling average increase.
Over the last 12 months, inflation has averaged a monthly increase of 0.65%. Significantly above our 0.4% projection. However, a 0.4% monthly increase over a 12-month period is still well above the 2% annual inflation target.
If inflation runs at the 0.4% monthly rate, we could see inflation stay relatively flat throughout the end of the year finishing slightly up at 8.7%. It would also see GDP finish above 156.6, significantly above the projected year-end of 154 that some experts are expecting.
In our more aggressive scenario, it shows inflation finishing out 2022 just below 10.8% and CPI ending the year just above 159.5.
US inflation was reported higher once again in June, reaching 9.1% year-over-year a full 1% higher than Canada. This was well above May which saw inflation at 8.6% and well above the projected 8.8% for June.
US Inflation Looking Forward
Using much the same scenarios as outlined above for Canada, we see that the US will be in much the same situation. Over the past 12 months, the average monthly increase in inflation has been 0.73% only slightly higher than Canada. However, much of that was at the end of 2021. Canada’s inflation has been running hotter than the US every month in 2022 except for June.
Both of our two forward-looking scenarios have inflation for July above 9% and up to 9.2%. Our more conservative scenario has CPI finishing out 2022 at 305.3 with inflation at 9.5% for all of 2022.
Our more aggressive scenario has CPI ending the year at 308.6 and inflation at 10.7%.
States Providing More Stimulus
Most people are willing to acknowledge that the fiscal and monetary policies of the last 2+ years have been a net negative for the economy. Many also believe, and rightly so, that the helicopter money in the form of stimulus cheques is a large reason for the runaway inflation we are experiencing right now.
Assuming that stimulus is at least partially to blame for the inflation, a logical person would assume that the way to get out of this mess is not by injecting more stimulus. However, 14 States are set to implement stimuli to deal with inflation.
Maybe they are living by “the hair of the dog that bit you”. Normally used in the context of a hangover, where the belief is the best cure for the hangover is to continue drinking. Seems to be pretty illogical in the context of inflation. Stimulus caused inflation, how do we cure inflation? More stimulus. I believe there is a saying, that the definition of insanity is doing the same thing over and over again and expecting a different result.
For our thoughts on helicopter money check out: Helicopter Money to Increase Short-Term Inflation
2022 is now more than halfway done. Crazy! It has been a tough year for many people when it comes to the economic front and rising costs. Whether raising rates will play a significant role or do much to combat inflation is yet to be seen. In the grand scheme of things, rates are still extremely low. However, both governments and consumers are extremely leveraged.
Inflation continues to rise, and yet some states are thinking of implementing more stimulus. Will this add to inflation? I guess we will find out. Governments continue to raise rates drastically, but how much higher can they go? If they raise rates too quickly, will it push the economy into a recession and will deflation replace inflation? When the economy officially enters a recession, will governments reverse course and start lowing rates? Many questions remain to be answered.
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