Greg Gerber posted on March 14, 2008 12:17
NEW YORK -- Today’s consumer price report helped take a bite out of inflationary concerns with overall prices in February unchanged relative to January.
Market expectations had been for prices to be up 0.2 percent. Steady prices in the month helped push the year-over-year rate down to 4.0 percent from 4.3 percent in January. It was a similar story on a core basis with prices unchanged in the month versus expectations of a 0.2 percent rise. As a result, the annual rate dropped more than expected to 2.3 percent in February from 2.5 percent the previous month.
Flat prices in the overall index were helped by energy prices dropping 0.5 percent in the month. This largely reflected gasoline prices falling 2.0 percent. However, this was offset by food prices rising a hefty 0.4 percent. The benign performance on a core basis reflected relatively broad-based weakness possibly reflecting the weakening in economic activity.
New vehicle prices fell 0.3 percent in the month with a similar decline recorded in apparel prices. The marked weakness in housing activity likely contributed to household furnishings and operations component remaining unchanged in the month.
The Fed will likely take some comfort from the weaker-than-expected February consumer price report. Though the year-over-year rate in overall prices remains high this has not prevented core price increases on an annual basis moving closer to an implicit inflation target closer to 2 percent.
The report provides some tentative evidence that the weakening in economic activity is contributing to containing inflationary pressures emanating from rising energy and non-energy commodity prices. This will allow policy to remain focused on limiting the extent of any slowing in growth from the ongoing housing market meltdown and credit tightening.
Thus RBC Financial continues to expect that Fed funds will be cut a cumulative 100 basis points over the next couple of months with 50 basis points projected at next Tuesday’s FOMC meeting. The central bank may also continue to introduce measures, similar to this week’s Term Securities Lending Facility, to ease pressures and illiquidity in specific asset markets.
Canadian productivity declines in the fourth quarter
Canada’s business sector recorded a disappointing 0.8 percent drop in productivity in the fourth quarter following a downwardly revised 0.1 percent gain in Q3 (originally reported as up 0.2 percent).
Expectations had been for the fourth quarter to show a more moderate decline of 0.2 percent following the earlier-released and disappointingly weak Q4 GDP report. The surprise in the Q4 productivity numbers was that hours worked soared 0.8 percent in the face of the 0.1 percent rise in output.
For 2007 as a whole, the Q4 weakness contributed to growth in labor productivity slowing to only 0.5 percent, down from an already modest 1.1 percent gain in 2006. In 2005 productivity rose a more encouraging 2.5 percent.
With productivity declining 0.8 percent in the fourth quarter and compensation rising a solid 0.6 percent, unit labor costs shot up 1.4 percent. The picture for 2007 as a whole is not any more encouraging. The modest 0.5 percent rise in productivity only partially offset a 3.7 percent jump in compensation. As a result, unit labor costs rose a robust 3.2 percent and well in excess of the Bank of Canada’s inflation target of 2 percent. The annual rate of increase in unit labor costs has been steadily rising from the 2.4 percent recorded in 2004.
The drop in productivity in the quarter is disappointing as it implies greater upward pressure on overall prices coming from labor costs. This was evident in today’s report as growth in unit labor costs has risen steadily from 2004 reaching an inflationary peak in 2007 of 3.2 percent. This does suggest some upside risk to the inflation outlook.
However, actual inflation numbers has generally becoming in below target. For example, core CPI was only up 1.4 percent in January and thus well below the Bank of Canada’s mid-point target of 2 percent. The recent appreciation of the Canadian dollar may be providing some offset though this will only provide a temporary respite.
However, despite the negative implications for inflation from today’s report, RBC Financial expects that the Bank of Canada will remain focused on the near-term growth outlook. The growing risk of the U.S. economy slipping into recession will keep the Bank of Canada easing policy.
RBC Financial expects that the Bank of Canada will cut the overnight rate a cumulative 50 basis points with the cuts being split over the next two policy meetings in April and June. These cuts are expected to send the overnight rate down to a near-term trough of 3.00 percent by mid-year.