Recent gains in the Canadian dollar, soft labour costs and lower energy prices are temporarily holding back inflation, but in the medium term, the inflation rate is expected to rise, says a new report by CIBC Capital Markets.

The report, entitled Canadian Inflation: What’s Gone Wrong? was written by CIBC chief economist Avery Shenfeld and senior economist Nick Exarhos. It also looks at the impact of certain inflation drivers, like the regional housing boom, on the overall consumer price index (CPI) measure.

Consumer price index inflation

"For each of the issues we looked at, the impacts are in the range of a decimal place or two on the CPI. But when added together, they're material enough to push CPI inflation above the 2 per cent target by next spring," says Shenfeld.

"That won't be alarming to the Bank of Canada, given how long inflation has run below target. But it might add a dose of pressure to long-term rates and breakeven inflation assumptions in the real return bond market, given how dovish current market expectations are for Canada's CPI," he says.

Bank of Canada rate hike

Shenfield also points out that the July 12 rate hike by the Bank of Canada is “resulting in a temporary drag on inflation.” This is the first rate hike in 7 years.

"By pushing the Canadian dollar stronger, the Bank of Canada's rate hike may have delayed achieving its 2 per cent inflation target. But not for long," he says. "A likely reversion in productivity to trend would, along with minimum wage gains, put pressure on unit labour costs, housing will add a couple of ticks, and we see oil higher in 2018 given that current pricing doesn't support positive cash flow for the marginal supplies needed from the United States."

Regional housing market

Regional housing market booms have not impacted the CPI because of low mortgage rates and because CPI measures take into account builders’ prices, which usually fall behind secondary market prices.

"Statistics Canada has advised us that a change in methodology for housing inflation is forthcoming, and we're guessing that a measure for house prices could be part of that change. But the key to why house prices have been MIA is that mortgages have been generally rolling over at lower rates in the last several years. That's about to change," he says.