https://www.cwbwealth.com/en/news-and-stories/insights/inflation-a-look-ahead
- Inflation duration
- Labour pains and gains
- What’s likely in the long term?
It’s been a tumultuous past few years. We’ve been knocked to and fro both in the markets and in the real world. A theme emerging for 2023 is that we’re closer to the end of the storm than the beginning. An example of this can be seen in inflation and interest rate expectations.
Inflation duration
Let’s take a look at Canadian inflation over the past two years (see figure 1). The grey line shows the spike up in headline inflation through to mid-2022, with a mild tapering towards the end of 2022. The teal line shows inflation excluding the two more volatile items – energy and food. It shows a similar story. What’s interesting is the blue line, which shows inflation momentum. Momentum has slowed rapidly, and this is something that the Bank of Canada very much wanted to see. Markets are expecting inflation to return to 2% by 2024, and this momentum chart supports that thesis.Figure 1: Canadian inflation

Source: Bloomberg, Statistics Canada
During 2022, supply chain issues and commodities were significant factors of inflation. Supply chain issues are rapidly abating, and commodities might even see some deflation in 2023. Shelter and big-ticket discretionary items are responding to interest rate pressure, and we’re seeing a return to normal inflation levels in these areas.
Labour pains and gains
Where we see continued inflation pressure is in the service sector, and labour generally. During 2020 and 2021, we saw a notable decline in participation by those over 55 years of age. A number of workers took the pandemic as encouragement to pull their retirement date forward. This early retirement exacerbated strains on the labour market from an overall aging population. We’re now starting to see an end to this “early retirement” participation decline.
It’s interesting to note that there’s been a sizable increase in participation by women with young children entering the work force. The flexibility of work-from-home may very well be making it easier for this demographic to participate in the work force. This could affect overall improved participation, which could relieve some of the labour pressure over the next year.
From a rates perspective, this means the Bank of Canada has likely finished its rate hikes for this cycle. Later this year, we expect shorter term yields to begin to decline as the market starts to anticipate possible central bank rate cuts coming in 2024. The outlook for longer term yields is different.
What’s likely in the long term?
Longer-term expectations are for inflation to return to a 2% level, and longer-term rates are already anticipating this. There are some additional influences that might affect longer term rates. National debt levels remain elevated throughout the developed world, with no signs of abating. Extra debt issuance will put upwards pressure on long rates. Central banks are going to be reducing their bond holdings, and that will also put upwards pressure on long rates. Further economic duress in emerging markets can cause a flight to safety, benefiting North American bonds.
The big risk to our scenario comes from unexpected inflation. If service sector inflation does not abate and labour productivity does not sufficiently improve, or worse, if long term inflation expectations become entrenched, then rates will have to move higher. We saw this happen in the 1970s, and today’s central bankers are well aware of history. We’ve seen repeated statements from various central bankers that they’re willing to err on the side of being too restrictive for too long, rather than cutting rates too early. Central banks are committed to fighting inflation, and to date, the market believes them.
Overall, we expect a slight downward movement in short-term bond yields, with minimal movement in longer term yields. 2022 was a negative return for bonds – well below returns seen over multiple decades. With yields being overall higher than we’ve seen in many years, bonds are poised to reverse this trend and offer an attractive potential in 2023.
Sources: Bloomberg, Statistics Canada
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