The Canadian economy got a bucket of ice water poured on it in June. Statistics Canada numbers show that the Consumer Price Index (CPI), one of the primary measures of inflation, has fallen to a multi-month low. This massive drop in the CPI may indicate that the economy is rapidly cooling.

CPI Falls To A 20 Month Low

CPI fell to a multi-month low, bringing huge questions about the health of the economy. The 12 month change in June came in at 1%. This is better than negative, but is far from the 2.1% we were looking at in January 2017. CPI decelerating at such a rapid rate brings up concerns of deflation. Deflation is arguably worse than high home prices, and generally only occurs during a severe recession.

Source: Statistics Canada.

Uh…What’s It Suppose To Be?

The Bank of Canada tries to maintain a target rate of inflation, to control a consistent supply of money. The target rate is 2%, although we’ve rarely hit that number in the past 5 years. The 5 year average has been 1.35%, when measured as a 12 month change. The median 12 month change is 1.3%. If the rate is too low, the economy is generally not doing so hot. If the rate is too high, the economy is overheating. If inflation is growing at half of the intended target, it’s tough to argue the economy is firing on all cylinders.

Uncharted Waters For Canada’s Central Bank

Normally the BoC has an easy gig, using pretty standard moves to control the money supply. When CPI gets too high, they raise rates to cool borrowing. When CPI is too low, they lowers rates to stimulate borrowing. Unfortunately, they’ve decided to play politics this year.

The BoC’s sole purpose is to control the money supply, and watch the target rate of CPI. Unfortunately, they raised rates while the economy was experiencing deceleration of CPI. Raising the cost of borrowing when inflation is tapering, could send that number into deflation. Deflation isn’t something developed countries generally experience. Once deflation hits it’s hard to prevent a deflationary spiral. That’s when the cost of goods lowers, which reduces production, leading to less employed people. Less employed people, leads to less consumption of goods, and it continues… you know, in a spiral.

Home prices needed to be cooled, but should have been done with legislative measures – not monetary. If all branches of government are watching home prices, who’s watching the flow of the money that should be fueling business growth? Afterall, lowering interest rates raises price. However, raising rates has historically had a minimal impact on cooling home prices.

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