We are coming to a fall inflection point…

For the investor, whether fixed-income or equity oriented, or both, inflation and interest rates remain topical and relevant. With the printing of this commentary, in order to slow the rate of inflation, the Bank of Canada has made the decision on Wednesday, July 12, to increase the bank rate by another 0.25% to 5.00%. There is a strong possibility that the Bank will increase short-term rates again on September 6th by another quarter point. In view of the fact that reported inflation for the 12 months ended in May came in at only 3.4%*, one would not be faulted for wondering why the Bank of Canada seems so intent on pressing hard on the interest-rate pedal.

There could be two key reasons as to why the Bank and many market analysts expect a higher inflation number in the next several months, and, it follows, a higher Bank rate. The monthly rate of inflation became decidedly subdued to slightly down between October and December of 2022. Coming off such low monthly inflation numbers last fall, it is highly likely that year-over-year inflation readings will be substantially higher than that reported in May of 2023. (The June annual inflation rate will be reported July 18*.)

Secondly, heading into the fall and winter seasons, there is some certainty that prices of imported food, largely from the US, will skyrocket. Tiff Macklem, the Governor of the Bank of Canada, can do little but watch, or does he have some tools to counteract the effect of food inflation? The answer lies in his ability to influence the value of the Canadian dollar versus that of the US currency. After reaching a low of $0.72 US to the CDN $ in mid October last year, the CDN currency now trades at over $0.75. By pushing up short-term interest rates, the Bank of Canada, all things being equal, can push the CDN $ higher, making it less expensive for Canadians to buy US goods, and, most notably, food.

Therefore, in the short term at least, look for annual inflation to be much higher in the fall and, with it, the Bank of Canada rates. These conditions argue in favour of low valuation stocks, companies with strong balance sheets to help withstand the effects of higher financing costs and a bond portfolio that gradually takes the opportunity to move from short-term maturities to longer-dated issues in the 3 to 5-year area.

*As of July 18th, Statistics Canada has reported the June annual inflation rate to be 2.8%