How likely is an inflation resurgence in Canada?

Top bank on chances of an uptick

How likely is an inflation resurgence in Canada?

The Canadian economy is less likely to experience the same inflation reacceleration as the US, according to RBC economist Clair Fan.

Despite close economic ties, the Canadian economy has been underperforming compared to the US since 2023.

"The recent outperformance of the US economy is led by the services sector—a driver that hasn't materialized in the Canadian economy to the same extent," Fan wrote in a recent blog post. "That makes it less likely that US inflation reacceleration will be replicated in Canada."

While services inflation has picked up in the US, it has continued to moderate in Canada. Manufacturing output has stalled in both countries due to slowing global demand, leading to a drop in goods inflation worldwide.

Historically, Canada and the US have had closely aligned economic performance due to their strong trade relationship and shared border. However, a recent divergence has emerged, with Canada experiencing a significant underperformance.

The gap in per-capita real GDP between the two countries reached its largest on record in Q1 2024, and inflation readings have also begun to diverge.

The lagging Canadian economy, however, is helping ease inflation faster than in the US. RBC expects the Bank of Canada to cut interest rates before the Federal Reserve based on differing outlooks.

This divergence has implications for monetary policy, with the Bank of Canada expected to cut interest rates sooner than the US Federal Reserve due to Canada's lower inflation.

Read more: How would a Bank of Canada cut change Canada's mortgage outlook?

“The Canadian economy is continuing to underperform even as interest rates are set to drop slowly from high levels,” Fan said. “We expect Canadian GDP growth will stay soft this year, rising by just 1.3% as households continue to grapple with elevated borrowing costs.”

The combination of sluggish economic activity and easing global supply constraints should keep Canadian inflation lower regardless of strong US demand, according to RBC's analysis.

“The BoC and the Fed have been focused on ‘super core’ inflation measures that are designed to get a better gauge of price pressures due to domestic services consumption (outside of shelter),” Fan said. “This measure has continued to edge lower in Canada in early 2024, but has started to reaccelerate in the US. There is little reason to expect that divergence in service sector price growth will narrow in the near term.”

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