CPI in Oct has sparked another wave of inflation fears as both sides of the border see prices surge to new highs in decades. StatsCan reported an unprecedented 4.7% price jump in 18-year history, while the US consumer prices climbed by an alarming rate of 6.2%, the worst of 31 years. News coverage over sharp price rises and surging cost of living dominates the media headlines, raising widespread concerns that inflation is more persistent than Feds' transitory narrative. Amid widespread speculations over the Fed's consecutive moves to raise interest rates, spooked bond investors have priced multiple rate hikes in the next 12 months.
The Fed and central banks tend to decrease inflation by raising interest rates, making borrowing more expensive to cool off economic activities and price gains. But rapidly sharp rising interest rates can negatively affect the economy, wreaking havoc on Canadian household finances. It will drastically increase the monthly loan payments as Canadians' household debt to disposable income reaches a record high. In particular, rate hikes will affect $350 billion in mortgages in 2022, putting pandemic homebuyers in a bind. In extreme events such as the rate hikes during the 1970s recession, the mortgage rate peaked at over 21 percent in 1981, causing seemingly never-ending nightmares for homeowners at the time.
However, the good news is that economists believe that the latest CPI numbers prompt no urgent need for monetary authorities' intervention. The biggest driver of CPI's surge in Canada was a 42 percent increase in gasoline prices -- caused by a severe mismatch of supply and demand that rate hikes wouldn't help much. Meanwhile, the shortage of input led by supply chain bottlenecks will fade away over time. The average of BOC's three core inflation measures was only at 2.7 %, which falls within BOC's comfort zone for the inflation target range. The US data has also shown a silver lining behind gloom and doom. Economists estimated that around one-third of CPI component sectors are falling while half are growing at less than 2%. At the same time, the broad economic recovery is on the way while wage increases come along with productivity gains.
Economists believe that the Fed's intervention based on some pockets of spiking inflation might do "more harm than good." Both Fed Chair Jerome Powell and Bank of England Governor Andrew Bailey suggest that it is counterproductive that the central bank tightens policy in response to inflation caused by temporary supply shocks. Change in domestic monetary policy in Canada won't alleviate global inflation pressures. If it had not been for the concern about the public's outsized inflation expectations, the BOC would have “looked through” the recent burst of inflation, according to Financial Post.
The public overreaction to the latest CPI data may spark a wage and price spiral -- a vicious cycle causing rampant inflation during the 1970s recession. It took a series of rapid rate hikes to break the harmful process, which resulted in the overwhelmingly high mortgage rate in the 1980s. The central bank may raise its policy rate as early as April to influence inflation expectations. But to avoid the devastating impact of quick and forceful tightening policy, the market must try to keep the inflation panic under control, preventing inflation from becoming a self-fulfilling prophecy. Staying calm to a brief spell of the higher price level and trusting the monetary authority's ability to rein in inflation is the key to ensuring a smooth disinflation journey.
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