Economy in Brief

UK inflation gives the BOE a greenlight on rate cuts. UK inflation is still excessive at 3.8% over 12-months for the CPI-H and its core metric. But over six-months both of those drop; the headline drops to a pace of 2.9% and the Core drops to 3.0%. Over three-months inflation drops even lower to a headline pace of 2.3% and a care pace of 2.7%. Both are still above the 2% target but look much less dangerous.

Stauch inflation fighters still will not like the results. But with the unemployment rate a year ago at 4.2% and now up to 5% (as of August) and with a one-half-of-one percentage point rise in the unemployment rate in the last six-months it becomes hard to hold the line on monetary policy. The BOE’s rate changes have mirrored those of the Fed in the US, but with the official; unemployment rate at 4% now and short-term inflation readings around 2 ½ percent and unemployment rising it would be hard for the central bank, especially given the turbulent UK political scene, to squeeze the economy further. IN the UK inflation is deflation whereas in the US inflation is stuck, possibly rising and facing the potential of pressure form tariffs.

Inflation diffusion checks in below 50% (the level that marks equal tendencies for inflation to accelerate or decelerate across broad categories) for 12-months, 6-months, and 3-months. Over recent months, month-to-month inflation has been contained in terms of broad categories with two of three months showing monthly diffusion below 50%.

It is hard to make any optimistic case for economic activity and if UK activity is going to slow, it is much easier to make a case for inflation containment to progress further. While the more up to date claimant count unemployment rate has been steady, the lagging overall rate has a clear uptrend that has to be viewed as worrisome.

Like the Fed I would surely like to see more progress on inflation in the UK and I do not view current circumstances as optimal to cut rates. But the situation is simply slippery. And monetary policy is made in the real world under conditions or uncertainty. And real-world conditions surely pave the way for some continued rate cutting unless data and trends shift.

In October, the CPI and Core rose by just 0.2% month-to-month with inflation rising in six of ten major categories month-to-month and after seeing only one category accelerate month –to- month in September and a split of five/five in August.

Still, make no mistake about it, inflation is still too high. The question of the bet by the central bank will be on the future. When UK inflation is ranked on Year-over-year monthly observations back to early 2000, inflation is below its median year-to-year rise in only two of ten categories and ranked on the same period the freshest unemployment rate has been lower about 46% of the time marking the current (rising) rate of unemployment as slightly below its median for this period. But the claimant rate that has stabilized at a lower level is nonetheless higher on this period, less than 30% of the time, which means the stability in the claimant rate is not as reassuring as it seems. It would appear that policy dialogue in the UK is about to shift.

Canadian growth has been in its own trajectory with some solid consumer spending in gear and some slight slowing in GDP growth. Housing has begun to show some wear and tear in this environment even as mortgage rates have remained well off peak and have begun to stabilize around the 5% mark for 5-year mortgage financing.

Canada has been cutting its policy target rate faster than the Fed has been reducing the Fed funds rate. Canada’s unemployment rate has hovered above the rate for the US and it has been rising; rising - not quickly - but with a bit more purpose than in the US. This may have encouraged the Bank of Canada to cut rates more aggressively with inflation fluctuating is the desired range set by the back of Canada.

Canadian housing starts show the ‘signature slowing’ during Covid and the strong post-Covid recovery that actually has boosts starts well above the average it had maintained for the five-year previous to Covid. Even not with new episode of weakness in train Housing starts are above the pre-Covid average in Canada- and facing higher financing rates than before.

Canada, like the US, is going through some difficult fiscal times. In addition, there is an ongoing Trump-Carney spat that is a heavy overlay on the bilateral relations so important to both economies. Canadian PM Mark Carney just survived a confidence vote over his budget. The Carney budget aims to pump funds into the Canadian provinces to boost infrastructure and house-building. In Canada builders also face development fees that some want altered but the offer of reducing them has not been put on the table. Not surprisingly Canada is under some of the same pressure as the US for the government to act and supply answers for the housing shortage that has emerged. Carney’s platform on which he was elected had made some substantial promises and they still are not coming to fruition.

Covid seems to have upset a number of apple carts many of them related to housing. Prior to Covid housing demand had not been so vigorous. But Covid may have triggered something that reminded people how important housing can be especially in a crisis when you become house-bound. In the wake of Covid US and Canadian housing demand strengthened. And since the bank of Canada made the same policy mistake as the Fed driving interest rates to the brink of the zero bound during Covid it also created a period of super low mortgage rates which now has the effect of trapping people in their own homes- a form of "golden-handcuffs" that keep people in a house because of cheap financing. While mortgage rates are nearly 150bp below their post Covid peaks, they are still more than 100bps above their pre-Covid averages. The housing market remains under duress.

Inflation around the world appears to be rather similarly behaved Canada is a very close trading partner of the United States and so we might expect that there would be a little more connection between the prices in Canada and in the US and possibly we can learn something about the upcoming US CPI report by looking at the just-released Canadian CPI report.

Canadian inflation is highly correlated with inflation in the US. The US and Canadian CPI's have a correlation of 0.97 on annual percentage changes. Canada's CPIx measure has a correlation with the US headline CPI of 0.94 and the Canadian core inflation rate has the correlation with US core inflation rate of 0.94. All of these measured against year over year inflation. Clearly with a good deal of trade and a long common border prices in the US and Canada have a chance to mix it up and affect one another and create some degree of homogeneity. However, none of that is really perfect. Despite the strong correlation between headline inflation and core inflation between the US and Canada, Canada's core CPI and the US core CPI have a correlation based on month-to-month changes of less than 0.2 Using an R-squared metric.

Well, it might be somewhat comforting to look at Canadian inflation, and I think it's giving some guidance for the US. That would only be true over a long period of time, but it probably doesn't provide much guidance for us in terms of what we can expect from the month-to-month changes.

While Canada's correlation with US inflation is high it's correlation with inflation in Japan it's only 0.33: only 1/3 of the variants in these two indicators is in common. In terms of the Euro-Area the correlation is less than -0.1, which tells us the correlation is negative and extremely small and of course not statistically significant.

The Canadian CPIx measure shows inflation pretty flat at around 2.6% over 3 months and over 12 months. Canada's 6-mo CPI measure accelerates from 2.2% over 12-months to a 2.6% annual rate over 6-months to a 3% pace over three months. US inflation on these horizons essentially replicates what's presented by Canada's CPI X based on existing data. However, the R-squared association between the three month annualized percent change in the Canadian CPI versus the US CPI shows that they share about half of the same variation with an R-squared of about 0.5. And on this comparison Canada’s and US’ recent inflation trends appear to be highly similar.

The Bank of Canada looks at inflation using several different metrics and it also looks at inflation relative to a range unlike the US, leading to a much more measured discussion of what inflation is and how it's performing.

The decision by the Fed in the US to stick with a simple point forecast at this point is something that probably cannot be changed, at least not until the central bank is able to show that it can hit that target consistently. Even so, the Fed has not showed a great appetite for trying to express inflation in terms of a target band. However, when the Fed changed its framework agreement it did adopt something called flexible average inflation targeting (FAIT) which never really described for us or explained what it was and it has a set that approach aside I think to the pleasure of most economists.

There continues to be buzzing and differences of opinion over what the inflation target should be in the US. However, the international standard has been set at 2 per cent and at this point adopting a number different than that doesn't seem to make a lot of sense. Adopting 2% with some flexibility might make some sense but, of course, the Fed is already doing that as it's allowed a 4 1/2-year overshoot of its inflation target as it continues to cut rates. This decision, however, does not amount to a change in the Fed’s inflation targeting but rather to a set of decisions that appears to be losing the Federal Reserve credibility. Meanwhile, the Bank of Canada, operating with the range and having had much the same kind of access that the Fed has had in hitting and missing its inflation target midpoint, has emerged from this period with its credibility largely intact.