Cue the recovery, but watch for inflation

As the Canadian economy zigs and zags through the latest pandemic lockdowns, frustrating forecasters yet again, CIBC’s Benjamin Tal remains optimistic about a strong rebound in the second half of the year. But he’s also wary of inflation.

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“Inflation is like that brown spot on the banana,” said Tal, CIBC’s deputy chief economist, in a May 3 interview. “By the time you see it, it’s way too late.”

Inflation is a lagging indicator, Tal said. And while prices may accelerate over the next few months — Statistics Canada reported the annual pace of inflation rose to 3.4% in April, the highest level in a decade — Tal said the hope remains that inflation will stabilize between 2% and 2.5% over the next year.

As with everything in the pandemic economy, though, inflation is hard to predict. Booming commodity prices are a sign of inflationary pressure, but some experts attribute the surge to temporary bottlenecks as the economy recovers and base effects from a year ago. Canadian gasoline prices in April, for example, were up 62.5% on a year-over-year basis after prices plunged early in the pandemic last year.

Tal is betting on a strong recovery as the service sector rebounds once more Canadians are vaccinated. The Covid-19 recession is “very deep but also very narrow,” he said. “If you feel the pain, the pain is very severe. However, the number of industries that are significantly impacted in a negative way is much smaller than in any other recession.”

Because all the economic damage is in the more flexible service sector, the rebound will be fast once people are able to travel and go to restaurants again. Canadians sitting on $100 billion of excess cash will provide the fuel.

“This money is sitting there in chequing and savings accounts collecting 0% interest,” Tal said.

Once the economy reopens, this “excess cash” will be spent on services — “exactly where you want it to be,” he said.

But because inflation is a lagging indicator, it’s possible for central banks to find themselves behind the curve, Tal said. This is especially risky when they’re printing money at an unprecedented rate.

“When you chase a lagging indicator, you raise interest rates way too quickly,” he said. While that’s not the base-case scenario, “any investor has to think about this risk, because at this point nobody knows what inflation will do six or eight months from now.”

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Mark Burgess

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Mark was the managing editor of Advisor.ca from 2017 to 2024.