A customer fills his car at a gas station in Ottawa on Monday. Until the war in Iran, the world was making progress on wrestling inflation back to target.Keito Newman/The Globe and Mail
Five years ago this month, Canadian prices first started to spin out of control, setting off the worst inflationary episode in 40 years. As unhappy a birthday as that is, the flame has already been lit on the next candle to be added to this bitter cake.
Until the war in Iran, the world was making slow but steady progress on wrestling inflation back down to target. Suddenly, the second inflationary scare in five years is upon us.
In March, Canadian prices rose by nearly 3 per cent year-over-year, after removing tax effects. That’s up from 1.9 per cent the month prior. The next batch of data will almost certainly be worse.
In the United States, headline inflation could easily hit 4 per cent by the summer. If the war in Iran lasts much longer, global inflation is likely to push past 5 per cent on the year, the International Monetary Fund said last week.
The refrain of the moment: “Looking through” the war’s immediate effects. That’s what Tiff Macklem said the Bank of Canada will do. It’s the consensus among economists as well. Investors, too, judging by the record high notched by the S&P 500 Index on Friday. Everyone’s looking through.
The dominant assumption is still that this mess will be unwound in short order, the financial fallout contained and a price shock averted. But the war is already two months old. The Strait of Hormuz is still being blocked, fuel is being rationed throughout Asia, flights are being cancelled everywhere and an inflationary impulse is building by the day.
“Another wave of inflation has begun; where it stops, no one knows,” Scott Anderson, chief U.S. economist at Bank of Montreal, said in a note to clients. “This energy price shock may have a longer tail than investors currently believe.”
Canada’s inflation rate hits 2.4% in March as war fuels highest monthly gas-price increase on record
When the International Energy Agency flagged the conflict as “the greatest global energy threat in history,” it brought to mind the oil crises of the 1970s – gasoline station lines, recession, runaway inflation and stock market carnage.
A lot has changed since then. The modern economy is much more energy efficient. The fuel economy of the average car has more than doubled in that time. Our homes are much greener as well.
On an economy-wide scale, the amount of energy required to generate a dollar of gross domestic product in the U.S. has dropped by about 40 per cent since 2000.
This should provide some protection from the recent spike in oil prices, as many economists have been quick to point out. And if so, the economic blow should be dulled, and the lift to inflation contained.
But that’s only part of the story. Economic growth has mostly cancelled out the effects of improved efficiency. Since the U.S. economy has expanded by about 70 per cent over that time, total energy consumption hasn’t meaningfully declined. Mileage may have improved dramatically. But Americans drive more, their vehicles are larger and there are far more of them on the road. The same goes for Canada – energy intensity is way down, but total energy consumption is not.
“Policy makers and consumers alike should not expect the energy efficiency gains of recent decades to shield them from the current oil shock,” Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce, wrote in a note.
Canadian drivers have already been confronted by the largest monthly increase to gas prices on record. This is among the first-order effects of higher oil prices, acting as a tax on consumers worldwide.
Second-order effects start to emerge as higher input costs work through the economy. The agricultural sector, which relies heavily on diesel, is facing tough decisions in the middle of spring planting season.
The effect on farmers is compounded by the rise of fertilizer costs, with key nutrients such as urea up by 40 per cent since the war began. So, grain prices go up, which are then used as an input in meat and dairy production.
This is how inflation builds over time, until it eventually transmits to the grocery store.
“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,” Mr. Tal said.
Most unwelcome news for the Canadian shopper, who is grappling with grocery prices that are already 33 per cent higher than prepandemic levels.
Who knows, maybe Donald Trump declares victory on Truth Social tonight, the tankers start moving freely through the Middle East, the supply chain gradually clears the backlog, prices moderate, the harvest season is a success, the damage to Gulf energy infrastructure proves manageable, gasoline prices are slashed, and whatever food inflation that emerges in the coming months and years isn’t so bad.
It could happen. Right now it seems like an awful lot to look through.