In a report published Nov. 9, CIBC economists Avery Shenfeld and Helen Lao said elevated profit margins across parts of the Canadian supply chain, combined with a softer labour market and moderate income growth, could limit businesses’ ability to raise prices without losing customers.
The analysis challenges the Bank of Canada’s expectation that inflation will remain above three per cent through much of 2027, suggesting that businesses may have to absorb some higher production, import and wholesale costs to maintain sales volumes. The findings could also have implications for the central bank’s interest rate decisions, with CIBC suggesting that a more moderate inflation outlook would reduce the urgency for further rate increases.
Retailers and wholesalers have room to absorb costs
The report points to a growing gap between upstream business costs and the prices consumers are currently paying. While Canadian consumer inflation, excluding gasoline, is sitting at 2.2 per cent, several measures of producer and wholesale prices have increased considerably.
The wholesale trade price index is up 7.3 per cent year over year, while consumer goods entering Canada from abroad have increased 8.9 per cent. The industrial product price index, which measures Canadian producer prices, has risen 14.5 per cent over the past 12 months. The Bank of Canada has identified these increases as a potential source of broader inflation, anticipating that businesses will eventually transfer higher costs to consumers.
However, Shenfeld and Lao argue that companies may have less flexibility to increase prices than the central bank’s projections suggest. If higher prices discourage consumers from purchasing goods, retailers and wholesalers could be forced to reduce their margins rather than risk losing sales. CIBC’s analysis indicates that profit margins across several parts of the supply chain remain above historical averages, providing businesses with some capacity to absorb additional costs.
Retail operating profit margins increased during the pandemic and, although they have declined from their peak, remain well above the average recorded during the previous business cycle. Margins at food and beverage stores are also elevated compared with historical averages, while consumer goods wholesalers appear to have room to absorb additional costs without falling below pre-pandemic profitability levels. Canadian manufacturers in food and beverage processing, clothing, textiles, leather and furniture are also not showing significant margin pressure, with profitability sitting close to historical norms.
Economic conditions differ from previous inflation surge
The economists also question whether the inflationary experience of 2021-23 provides an appropriate comparison for the current economic environment.
When Russia invaded Ukraine in February 2022, global oil and grain prices increased sharply, while Canada’s economy was already experiencing strong demand and a tight labour market. The unemployment rate was 5.5 per cent that February before reaching 4.8 per cent in July 2022. By comparison, Canada’s unemployment rate is currently 6.5 per cent, according to the report. Households also had considerably more income growth during the earlier inflationary period. Aggregate wages and salaries increased 10.5 per cent year over year in the first quarter of 2022, compared with a 4.4 per cent increase currently.
CIBC said slower hiring, weaker population growth and less upward pressure on wages have reduced the purchasing power available to households, making consumers potentially less willing or able to absorb additional price increases. The report identifies 2011 as a more relevant comparison. At that time, an oil price surge associated with supply disruptions during the Arab Spring created inflationary pressures, but economic slack and relatively weak demand limited the extent to which higher costs spread throughout the consumer price index.
Businesses also anticipated passing on higher input costs in 2011, but competitive pressures and sluggish demand ultimately prevented many of those increases from materializing. CIBC said a similar dynamic could emerge in the current environment, even though businesses surveyed by the Bank of Canada have reported higher input costs and expectations of passing on significant price increases.
Core goods prices remain key inflation indicator
The report identifies core goods inflation as an important factor to watch in determining whether the Bank of Canada’s inflation concerns materialize.
The central bank’s October Monetary Policy Report projected that core goods prices could reach a year-over-year increase of 3.6 per cent in 2027, which would be the second-highest rate in the past 30 years, exceeded only during the pandemic. That increase would significantly raise the contribution of core goods to overall inflation, with only a small portion attributed to Canada’s newly imposed counter-tariffs.
CIBC’s economists said the projected increase appears to assume a degree of price acceleration more consistent with a stronger economy than the conditions currently facing Canada.
Their forecast allows core inflation, excluding food and energy, to move above the Bank of Canada’s two per cent target, with core goods contributing more than historically typical. However, they expect a gradual easing in gasoline prices could help keep overall inflation in check. The economists said the extent to which businesses can pass on higher costs will depend on consumer demand and whether customers continue purchasing goods at higher prices.
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