The pace of inflation has picked up on both sides of the border, but Canadian prices probably won’t rise as quickly as U.S. prices, according to a report from CIBC Economics.
The loonie is one reason Canada is expected to experience slower inflation than the U.S. Since the start of the pandemic, the Canadian dollar has appreciated by 7%, providing a “cushion on inflation” by reducing the cost of imports, the report noted.
About one quarter of Canada’s consumer price index is made up of imported goods. The rising loonie has led to a decline in import prices year over year, while import prices in the U.S. have climbed sharply and currently sit at about 7% above pre-pandemic levels.
During the financial crisis, a similar phenomenon played out: the Canadian dollar appreciated, and Canada’s inflation rate lagged the U.S.’s by about 2.5 percentage points, the report said.
While the loonie is expected to lose ground, Canada’s larger output gap relative to the U.S. will help offset inflationary pressure, CIBC predicted. The bank expects Canada will close its output gap by the end of 2022, at which time the Bank of Canada will likely look at rate hikes.
But the BoC’s rate hikes probably won’t be as high as what the market is pricing in, the report suggested.
That’s because Canada is more sensitive to rate hikes than the U.S. — a holdover from the aftermath of the financial crisis, when Canadian households accumulated debt at a faster pace than American households.
The share of sectors sensitive to interest rates — namely, housing — is twice as large in Canada as it is in the U.S., which makes monetary policy more effective for the BoC than it is for the Federal Reserve, the report suggested.
“That asymmetric response to rising rates is behind our expectation that Canada will not only enter 2022 with more economic slack, but will be able to lean against an overheating and contain inflation with a less aggressive pace to rate hikes,” the report said.
CIBC predicted inflation in Canada will average 2.8% and 2.2% in 2021 and 2022, respectively, while U.S. inflation will average 3.8% and 2.9% over the same years. For further details, see the report.