Michael Watkins
August 18, 2023
Weekly Market Update
It’s all about inflation this week. Canada’s inflation rate ticked higher in July but remains well below the multi-decade highs reached in 2022. Still, the inflation rate remains above the Bank of Canada’s (BoC) 2% target and keeps the pressure on many Canadian households and businesses. The BoC’s work might not be over yet
- Canada’s annual inflation rate rose to 3.3% in July from 2.8% in June. According to a Bloomberg survey, economists were expecting a year-over-year rate of 3.0%.
- Upward pressure on prices came from rising costs for electricity and mortgages. Mortgage costs rose at a record pace of 30.6% year-over-year in July. Conversely, the drop in energy costs slowed in July compared to June. Gasoline prices fell by 12.9% year-over-year.
- The slight drop in Canada’s core inflation rate provided evidence of progress toward lower consumer price growth. Based on two measures tracked by the BoC, Canada’s core inflation rate eased to 3.65% year-over-year in July from 3.70% in June.
- Some critical economic announcements from elsewhere in the world helped drive global markets yesterday. U.S. retail sales rose by 0.7% in July over the previous month, suggesting U.S. households remain relatively resilient. In China, the People’s Bank of China reduced its one-year medium-term lending facility by 15 basis points to 2.50% amid weak economic conditions.
Attention now turns to the BoC, whose next interest-rate announcement is on September 6. While markets currently expect the BoC to hold steady, this inflation report could make the decision more complicated. The BoC seeks to bring inflation back to its 2% target but might need to pause to assess how recent rate hikes impact inflation and the Canadian economy.
Turning to the States, the US Federal Reserve Board’s (Fed) internal discussions about inflation became public knowledge this week with the release of the minutes from its July meeting. Most officials remained cautious about persistently high inflation; however, there was acknowledgment of potentially easing inflationary pressures. Meanwhile, research from the Federal Reserve Bank of San Francisco indicated that savings built up by US consumers during the pandemic are running out.
- The Fed’s meeting summary included concerns that further monetary policy tightening could be warranted in response to higher inflation.
- Despite positive strides, inflation remained above the Fed’s 2% target. Further data is deemed necessary to confirm the trend toward target.
- Consumer prices rose in July by 3.2% compared to the previous year, primarily influenced by escalating fuel and food expenses.
- However, this is positive versus inflation’s peak. Despite the inflationary pressures, July’s rate is considerably lower than the peak in June 2022.
- Economic strength endured during the rate-hiking cycle. The US economy has been resilient even with rapid interest-rate hikes, demonstrated by the dip in the unemployment rate to 3.5% in July.
- However, pandemic savings could soon be finished. Recent research suggests that these savings, which have supported the economy, could run out by the third quarter of 2023.
The minutes reveal some of the Fed’s nuanced stance on inflation. Policymakers are being cautious as further monetary tightening could be needed, while being mindful that there could be some relief to high prices. The ongoing resilience demonstrated by the US and Canadian economies, even amid a backdrop of interest-rate increases, suggests a more balanced outlook.
Across the pond, inflation is coming down in the U.K., in part due to the aggressive rate hikes from the Bank of England (BoE) over the past year and a half. But the decline doesn’t mean the U.K.’s challenges with inflation are complete just yet. Inflation remains elevated and well above the BoE’s 2% target, which could prompt more rate hikes by the U.K. central bank.
- The U.K.’s annual inflation rate was 6.8% in July, its lowest year-over-year inflation since February 2022. July’s inflation number was down from June’s rate of 7.9%. It did, however, come in above the 6.7% rate economists were expecting, according to a survey by Bloomberg.
- Downward pressure on prices came from falling costs for fuels and lubricants, which dropped by 24.9% year-over-year. Meanwhile, price growth slowed for food and beverages, along with furniture and recreation.
- Core inflation, which excludes more volatile items, remained elevated at 6.9% year-over-year in July, unchanged from June.
- Producer price growth dropped for a second straight month, declining by 3.3% year-over-year in July.
- Despite July’s decline, U.K. inflation is still too high for the BoE and will likely keep the bank on track to lift interest rates further. The BoE has already raised rates at fourteen straight meetings to 5.25%.
The BoE and other major central banks, such as the U.S. Federal Reserve Board and Bank of Canada, are grappling with how to react to softening inflation that remains too high. While looking to push inflation down further, they need to tread carefully, as taking interest rates too high could push the economy into a recession. While it is difficult to predict how central banks might respond at upcoming meetings, we can safely expect an economic environment of higher interest rates for longer.
Finally, the world’s appetite for oil has reached a historical peak, unveiling intriguing dynamics in the global energy landscape. The International Energy Agency’s (IEA) latest report sheds light on the supply-demand scenario that challenges some prevailing assumptions
- Pandemic predictions upended. At the height of the pandemic, when work-from-home trends were in full swing and oil demand at lows, some forecasts called for lower global oil consumption over the long term.
- However, latest IEA report points to record consumption. In June, the world consumed 103 million barrels of oil per day, driven by increased air traffic and higher use of oil to produce power. Demand for oil from China for petrochemical production also contributed to demand.
- Mismatch between supply and demand. Although demand is increasing, OPEC+ has restricted output, which was around a two-year low in July.
- Energy transition could shift demand. The IEA believes that oil demand could continue to trend up this summer. Oil inventories in developed countries are below their five-year averages. But in the long term, the introduction of electric vehicles could alter demand.
As the world’s appetite for oil continues to break records, it highlights the remarkable ability of industries to adapt and evolve. Yet, the delicate equilibrium between supply and demand is a pivotal consideration, impacted by the calculated output restrictions implemented by OPEC+. In addition, the oil market will likely be heavily impacted by the energy transition and adoption of electric vehicles.
As always, please give us a call if you have any questions, or if you’d like to book a portfolio review.
Source: CIBC Morning Market Brief