A new report from BMO Economics says Wednesday’s inflation numbers could reach a staggering 7.4% (up from 6.8%).

This figure is almost as dramatic as the situation in the US, where inflation hit 8.6% in May.

“Arguably, this past week saw markets, investors, central banks, and forecasters finally cast off any remaining denial on the inflation front,” writes BMO Chief Economist Douglas Porter in the report. Porter references the latest inflation data in the US; the May Consumer Price Index (CPI) and inflation expectations from the University of Michigan’s consumer sentiment survey, which revealed headline rising (to 8.6%) and five-year expectations heading up to 3.3%. 

As a result, says Porter, the Feds felt the “need for immediate speed” south of the border. However, he says Federal Reserve Chair Jerome Powell “abruptly discarded prior forward guidance in favour of Wall Street Journal guidance” in the days following the data release. 

READ: Bank of Canada to Follow U.S. Fed’s 0.75% Hike in July

Porter highlights how, in the five sessions after the CPI release (i.e., up to Thursday’s close), the S&P 500 promptly shed 8.7%, moving into ‘official’ bear market territory. “Treasuries went on an absolutely wild ride -- many maturities took a peek at 3.5%, before relenting -- with 2s rising a net 31 bps over the five days,” writes Porter. “And, after a relative period of calm, credit spreads gapped higher through the week. Essentially, with the dawning realization of how much work still lies ahead for the Fed, markets began to price in the rising risk of an economic hard landing.”

july inflationSkyscrapers in downtown Toronto, Ontario, Canada

When it comes to how high rates will need to climb to calm the economy, Porter says that BMO’s view is that growth will be highly sensitive to a combination of coming rate hikes, the drag from inflation, quantitative tightening, less fiscal largesse and -- in the US, at least -- a strong dollar. 

Porter predicts notable rate hikes south of the border. “We now expect the Fed to hike rates to the 3.25%-to-3.50% range by year-end (a 25 bp lift from previously), and then stay there,” he writes. “Recall that just barely three months ago, the funds target was still 0-to-0.25%; this call would imply 325 bps of tightening in nine months.”

A 325 bp rise will make a major dent in growth, says Porter, resulting in the stalling of the gross domestic product (GDP) late this year and into early 2023. “In fact, there are early signs that growth is already catching a chill from high inflation, and even rising rates,” writes Porter. “A big pullback in housing starts last month may be a first warning that near-6% mortgage rates will take a fast toll. The Atlanta Fed’s GDP Nowcast is already looking for no growth in Q2, after an actual 1.5% dip in Q1.”

Porter points to few reasons to believe that inflation pressures could relent sooner than a normal cycle for a few reasons: calmer demand for goods could help alleviate supply chain issues and perhaps even the chip shortage; the super-heated labour market could turn quickly, cooling 6% wage growth; and commodity prices, especially energy costs. 

“Having said all that, we’ll make a nod to our bias of the past two years -- that inflation will not recede without a serious fight,” writes Porter. “But at the very least, markets have now fully taken that view on board, and are well aware of the challenge ahead.”

This brings us back to Canada. “Canada is poised to receive (yet another) loud message of the coming intense inflation fight,” Porter writes. He says that Wednesday’s May CPI in Canada threatens to be even more dramatic than its US counterpart. 

According to Porter, we can expect a 12% hike in gasoline prices to drive a monthly move of above 1%, raising headline inflation to 7.4% (from 6.8%). He says the risks seem skewed to the upside on his call. 

“In the event, we suspect that this will be enough to convince the Bank of Canada to also unleash a ‘highly unusual’ 75 bp rate hike next month,” writes Porter. “Like the Fed, we have also bumped up our call on the end point for BoC rates by a quarter to 3.25%, bringing the cumulative expected tightening to 300 bps. Historically, that’s not really out of bounds in a Canadian context -- but history had never seen household debt above 180% of disposable income before the past few years.”