Monday, January 18, 2010

Surging prices in the world's fastest-growing major economy are spreading. Is Canada next?

Tavia Grant

China exports everything from jeans and T-shirts to toys and computers. Is inflation next?

It's the latest worry about the world's fastest-growing major economy. Property gets the most attention, with prices now running at the fastest clip in 18 months. In Shenzhen, southern China's manufacturing hub, property prices have surged 19 per cent from last year.

Water prices are climbing, too, thanks to a new tariff. Prices for garlic, dried chili peppers and tea are also soaring. Stocks are roaring along with the economy; the main stock market surged 80 per cent last year.

The heat has already spread to nearby markets. Home prices in Hong Kong and Singapore are flying. Revived demand and rising house prices in Australia are sending interest rates higher. Meanwhile, ballooning prices for items such as rice and potatoes in India nudged its inflation rate to a one-year high of 7.3 per cent last month.

So ... Canada's next, right?

Not so fast. Canada's consumer price index is out Wednesday, and economists expect an annual rate of inflation of 1.6 per cent in December, faster than November's 1-per-cent pace, but hardly hot. "Inflation is low and will remain under control" in Canada, said Carlos Leitao, chief economist of Laurentian Bank Securities. Overall inflation may tick higher, due to year-ago comparisons when energy prices were plunging, but core consumer prices, excluding energy and food, will stay under wraps.

The reason is slack. Canadian factories are operating at about two-thirds of capacity. Most firms still have excess capacity, and the situation will persist for at least the next six months, a recent Bank of Canada survey showed.

Slack is also rife through the labour market, meaning muted wage increases. The jobless rate remains at a near-11-year high of 8.5 per cent, with 1.6 million people out of work. Recent salary surveys show only modest pay increases for this year.

Then there's the dollar. The loonie's 22-per-cent increase in the past year is driving down import prices and removing much of the sting from rising commodity prices.

Indeed, the key reason the Canadian inflation rate, to be revealed this week, will be lower than the U.S. pace of 2.7 per cent is the "restraining effect" of the currency on import costs, says Bank of Montreal deputy chief economist Douglas Porter. As a rough rule of thumb, every one-cent rise in the exchange rate knocks about 0.1 percentage points off inflation, he says.

The wrench comes if expectations for inflation change, Mr. Leitao said. "If there is to be a problem, it's not so much measured inflation as inflationary expectations. If those expectations start to rise, that's a problem. Then bond rates go up, and if market rates go up, the picture gets a lot more complicated."

Official inflation may be tame for now, but it doesn't likely feel that way for many Canadians. That may be because incomes haven't grown much in the past year. Also, prices for many everyday items, such as gasoline, car insurance, orange juice and pet food (oh, and houses), are running at a much hotter pace than the average.

Human psychology may also play a role too: We tend to wince when things get pricier, and overlook price declines elsewhere.