While goods inflation is subsiding, it remains an issue on the services side — likely spelling further rate hikes, a new report from BMO Economics says.
Key drivers of goods inflation, such as energy prices, have eased. For instance, mild winter weather in Europe and North America has led to a drop in natural gas prices.
“While highlighting the impact of climate change, the reality is that the freakishly warm weather and falling energy prices are a gift for Europe’s beleaguered 2023 economic outlook,” the report said.
At the same time, supply chain pressures have continued to ease, it noted, with recent data readings signalling reduced delivery delays.
“Part of the broader relief in supply pressure reflects a significant cooling in the demand for goods,” the BMO report said.
Yet, inflation worries aren’t abating just yet. “We would pound home the message that inflation is no longer an issue for goods, but is now primarily a services story,” the report said. “And, ultimately, services inflation is determined and potentially propelled by wage costs.”
To that end, BMO noted that wage growth will need to cool further before inflation can be expected to return to the central banks’ targets.
Yet the latest jobs data in both Canada and the U.S. point to persistent strength in employment.
“We continue to believe that underlying inflation will remain stickier than expected,” the report said.
As a result, BMO expects further rate hikes from both the Bank of Canada and the U.S. Federal Reserve — with the next round of consumer inflation readings likely to determine whether those hikes are 25 or 50 basis points.
“While job markets remain very tight in both economies, there is little doubt that broader inflation pressures are relenting, and the debate is now more one of degree and not direction,” it concluded.