This blog post is a follow-up to my April 2022 post “How Do You Like Them Apples?” which discussed the rising inflation and interest rates that were experienced in Canada in early 2022.
In an effort to reduce inflation, The Bank of Canada (the Bank) started increasing its benchmark interest rate on March 2, 2022. Over eight consecutive meetings, the Bank increased the overnight lending rate by 4.25%. The last increase was on January 23, 2023, bringing the rate to 4.5%. At the time, the Bank signaled that it was pausing future interest rate hikes, pending a review of future economic conditions.
The increase in the overnight lending rate is having the desired effect on inflation. The annual inflation rate in Canada peaked in June 2022 at 8.1%, and has decreased monthly to a low of 4.3% in March 2023. Contrary to expectations, the rate of inflation increased slightly to 4.4% in April 2023. Higher rent prices and mortgage interest costs contributed the most to the increase in inflation in April 2023. Compared to April 2022, Canadians are paying more in mortgage interest costs, as more mortgages were initiated or renewed at higher interest rates. The high interest rate environment causes home ownership to become increasingly unaffordable, increasing demand for rentals and contributing to higher rental rates.
As more household disposable income is spent on housing, Canadians are expected to reduce consumption, bringing demand down in the economy and restoring the balance needed to get inflation back to the Bank’s 2% target.
However, not all of the items included in the Consumer Price Index (CPI) fixed basket of goods have prices that are determined by consumer demand. Gasoline prices rose by 6.3% from March 2023 to April 2023 following an announcement from OPEC+ (countries from the Organization of Petroleum Exporting Countries Plus) to reduce oil output. An increase in carbon levies also contributed to higher prices. Some consumers may choose to walk or bike or take public transit in the face of higher gasoline prices. However, that is not an option for everyone.
Further, year over year grocery inflation was 9.1% in April 2023, more than double the overall rate of inflation. Food price inflation is expected to decrease over the coming months as cost pressures in production and distribution continue to ease. In the meantime, consumers purchase less or different kinds of food when budgets are tight. Some have to rely on charitable food to make ends meet.
According to the April monetary policy report, services price inflation is responding more slowly to the effects of restrictive monetary policy. In a speech to the Toronto Region Board of Trade on May 4, 2023, the Bank’s Governor Tiff Macklem noted that getting inflation from 3% back to the 2% target is going to be more difficult than it was to reduce it from 8% to 4%. In their forecast, the Bank expects that the labour market will soften as the economy slows and wage growth will ease; businesses will return to more normal price-setting behaviour; and consumers will stop expecting price increases to be inevitable and will become less willing to pay higher prices. Governor Macklem concluded his remarks by stating that the Bank is prepared to raise rates further if signs that inflation is likely to get stuck materially above the 2% target are observed.
I recently visited Starbucks with a friend and noted that a venti cinnamon dolce latte costs $7.00, including taxes. The accountant in me was curious about the profit margin for Starbucks’ beverages. Unfortunately, the aggregate data provided in the company’s annual financial statements didn’t provide the information I was looking for. However, my brief Google search yielded some interesting comments about Starbucks prices and inflation. Online comments noted that the company increases their prices quarterly and/or whenever there is a new product launch.[i] Some comments attributed the price increases to the current high level of inflation; others noted that the frequent price increases were contributing to the high level of inflation. The sentiment was consistent with Tiff Macklem’s recent remarks about services price inflation. Some customers, while acknowledging that the prices are high, accept the current pricing as a natural outcome of high inflation. And if demand is not affected by the increase in prices, the company will continue to raise prices. It is this pattern that will prevent services price inflation from slowing enough for overall inflation to get back to the 2% target.
The question is, at what point will consumer demand decrease enough to affect businesses’ pricing strategies? We have not yet felt the full effect of previous interest rate increases and will have to wait and see what happens in the coming months.
In the meantime, don’t buy the venti cinnamon dolce latte! I didn’t. I stuck with my usual tall dark roast coffee for $2.97.
[i] I did not fact-check these statements.
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