Inflation risks loom down the road as money is printed to battle recession: CIBC
Threat is higher for the U.S. than for Canada TORONTO, April 6 /CNW/ - CIBC (CM: TSX; NYSE) - Canada appears likely to adopt a much milder version of the U.S. and U.K. strategy of printing more money to fight the recession, a tricky measure that risks high inflation, or even hyperinflation down the road, notes a new report from CIBC's wholesale banking arm. "Printing money looks to be a key ingredient in preventing a global recession from tipping into a lasting depression," says Avery Shenfeld, chief economist, in his latest report. "A more aggressive monetary posture today should presumably hasten an economic recovery, and diminish the odds of an extended disinflationary period. However, it also raises the risk that policy makers will mishandle the timetable for unwinding unprecedented amounts of fiscal and monetary stimulus, leading to run-away inflation," notes Mr. Shenfeld. Printing money - formally known as quantitative easing - is a strategy where central banks use newly created money to buy government bonds that finance spending programs. Those extra dollars in the economy spur growth but can also shrink the buying power of each dollar, which is the definition of inflation. "Excessive inflation is indeed a hazard after a winning battle against deflation," says Mr. Shenfeld who believes inflation risks are greatest south of the border. With the U.S. "facing a sharp climb in government debt and a household sector similarly over-borrowed, inflation could be a tempting way to shrink the real value of those burdens. And even without a deliberate plan, it would be easy to err and unintentionally overdo the money pump-priming, or reverse it too late." Bank of Canada (BoC) Governor Mark Carney has downplayed expectations that the Bank will implement quantitative easing in April, Mr. Shenfeld notes. But "considering the deteriorating economic outlook, and with core inflation set to drop below the 1-3% band by late this year, further monetary stimulus will be required." Rather than announce an overnight interest rate cut in isolation, Mr. Shenfeld expects the BoC will "stand pat" in April and launch a Canadian-styled quantitative easing or credit easing program within the next three to six months. Canada's "gentler" approach will entail buying government bonds or other credits to lower longer term interest rates, while taking steps to neutralize the impact on money supply growth and overnight interest rates. "The BoC is much more committed to its strict inflation target. And Canada's government debt burden, while again on the rise, will still be much lower than Washington's, creating less of a temptation to simply inflate it away. Even so, Governor Carney will have his work cut out for him as he attempts to keep yields and long-term inflation expectations down with money supply growth already on steroids," says Mr. Shenfeld. If the Bank of Canada goes down the path of quantitative easing and a recovery takes hold, the first dose of monetary retightening will not be an overnight rate hike but more likely entail reversing the BoC's asset purchases by selling bonds back to the secondary market, says Mr. Shenfeld. "Anticipating that response, we've pushed back any Bank of Canada overnight rate hikes beyond our end-of-2010 forecast horizon." Mr. Shenfeld adds that "even if a spike in inflation doesn't materialize in the U.S., monetary retightening will be accompanied by substantially higher rates across the curve, as the Fed unwinds its balance sheet moves by selling bonds that it accumulated under a monetization mandate. That has us retaining our bearish view on long bonds, particularly Treasuries, with Canadas set to outperform. Meanwhile, to the extent that loose global monetary policy, including quantitative easing, boosts inflation concerns, that should be a positive for a commodity-linked currency like the Canadian dollar farther down the road." Elsewhere in the inflationary-themed report, Senior Economist Benjamin Tal writes that a recovery in oil prices beyond 2010 will heighten already soaring food inflation and force a fundamental change in agriculture and food systems. "The foundation of the modern agri-food system has rested on cheap energy, given the need to maximize yields in the face of constraints on arable land supply. But a recovery in oil prices, and the potential impact of environment policies to restrain its use, will turn this model on its head," he says. "The current disconnect between food inflation and overall inflation is an early sign of the upcoming changes in the economics of food. While fuel prices will remain subdued through 2010, a global recovery will have them rising more materially again beyond then, particularly if carbon taxes or emissions permits are imposed. In an effort to reduce energy intensity, farmers will increase organic food production whereas the food system as a whole will reduce its dependency on imports, and will become much more localized." The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/sapr09.pdf CIBC's wholesale banking business provides a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. 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