High Inflation Isn’t Over Yet

Inflationary Fears Resurface as Middle East Conflict Intensifies

Five years ago, Canada began experiencing a surge in prices, marking the most significant inflationary period in four decades. As we reflect on this challenging milestone, a new wave of inflationary pressure is emerging, fueled by the ongoing conflict in the Middle East.

Despite slow but steady progress in curbing inflation, the world is now facing a potential second inflationary scare within just five years. Canadian prices rose by nearly 3% year-over-year in March, excluding tax effects, a significant increase from the previous month’s 1.9%. Economists anticipate that upcoming data will likely reveal an even more concerning trend. In the United States, headline inflation could easily reach 4% by summer, and the International Monetary Fund warns that global inflation could surpass 5% annually if the conflict persists.

“Looking Through” the Crisis?

Many, including Bank of Canada Governor Tiff Macklem and numerous economists, are adopting a strategy of “looking through” the immediate effects of the war. Investors seem to share this sentiment, as evidenced by the record high achieved by the S&P 500 Index. However, with the conflict already spanning two months, the situation is escalating. The Strait of Hormuz remains blocked, fuel is being rationed across Asia, flights are being canceled globally, and an inflationary impulse is steadily building.

As Scott Anderson, chief U.S. economist at Bank of Montreal, cautions, “Another wave of inflation has begun; where it stops, no one knows.” This energy price shock may have a longer-lasting impact than currently anticipated.

A Familiar Threat, a Changed Landscape

The conflict evokes memories of the oil crises of the 1970s – long lines at gas stations, recession, runaway inflation, and stock market turmoil. While significant changes have occurred since then, including improved energy efficiency and advancements in fuel economy, the situation remains concerning.

The U.S. economy has become more energy-efficient, with energy required to generate a dollar of GDP dropping by roughly 40% since 2000. However, economic growth has largely offset these efficiency gains, resulting in a lack of meaningful decline in total energy consumption. This trend mirrors Canada’s experience, where energy intensity has decreased, but overall energy consumption remains relatively stable.

Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce, emphasizes that policymakers and consumers shouldn’t assume recent energy efficiency gains will shield them from the current oil shock.

Ripple Effects Across the Economy

Canadian drivers are already experiencing the largest monthly increase in gas prices on record, a direct consequence of rising oil prices. Beyond this immediate impact, second-order effects are beginning to emerge. The agricultural sector, heavily reliant on diesel, faces difficult decisions during the crucial spring planting season.

The rising cost of fertilizers, with key nutrients like urea increasing by 40% since the war began, further compounds the challenges for farmers. This, in turn, drives up grain prices, impacting meat and dairy production and ultimately leading to higher grocery costs.

“The high energy-intensity of agri-food means that food inflation will be one of the major casualties of the current oil price shock, lifting already high food prices even higher,” notes Mr. Tal. This is particularly unwelcome news for Canadian shoppers already grappling with grocery prices 33% higher than pre-pandemic levels.

A Glimmer of Hope?

While the situation appears dire, there remains a possibility of a positive resolution. A swift resolution to the conflict, increased oil supply, a successful harvest season, and manageable damage to Gulf energy infrastructure could lead to moderating prices and contained inflation.

However, as it stands, the current circumstances present a complex and challenging landscape that demands careful observation and proactive measures. The path forward remains uncertain, and the potential for sustained inflationary pressure is a significant concern.