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Payroll inflation 3.5% YoY April 2010 to 2011

The title says it all, wage inflation is rising in Canada.  This blog (and many many others) have been concerned that the BoC ultra accommodative interest rate policy would cause wages to rise substantially faster than warranted.  In a sense, it is a good reflection of the CPI which as of April 2011 has risen by 3.7%, but it also means that the lag that one would expect between wage inflation and price inflation is absent (which makes no sense), there is a problem here that will have to be addressed sooner rather than later.  

A combination of factors  are at play here:

(1)  Canadian unemployment at 7.1% (and 6.1% if using American statistical methodology) is getting close to the historical average of 5.5%, 
(2)  The Bank of Canada has made certain assumptions about Canada's output gap (the difference between potential and actual GDP), which still assumes a 15% gap (Q4/10 data).  Several economists take the view that this doesn't take into consideration that certain jobs will never come back -- and therefore the BoC is overestimating the size of the output gap, which means that Canada's economy is operating near its potential.
(3)  A strong housing market has both given Canadian a sense of wealth but also a keen understanding as to how expensive housing has become in Canada -- Montreal, Toronto and Calgary  to an extent, but Vancouver and Victoria has seen house price which everywhere else in the world would be considered bubble territory.
(4)  Canada is more unionize than the U.S.  and unions still have broad popular support -- Canadians understand the role of unions and these have not yet been demonized (although the new SunTV -- a Canadian "Fox" is certainly trying), so they still weld bargaining powers, moreover skills mismatch may explain why Canadian company are ready to pay more for labor, they just cannot find cheaper qualified personnel.

In a nutshell the BoC has a problem:  personal credit and house price have entered problem areas, certain tools have recently been deployed to address the housing issue (reducing the term of loans and decreasing maximum leverage), but these tool are like very large ships and are slow to act.  Once the wage inflation genie is out of the bottle, redressing will require excessive monetary tightening.  Wages increases are just an additional data point, if any were required, that the BoC will soon have to act because of strong inflation pressures, due to purely Canadian factors. 

Of course comparison with the U.S. shows that wage inflation in Canada is almost twice that of the U.S., moreover, since most American face rapid medical insurance cost inflation (in Canada it is absorbed by the Government), the difference is in fact even higher.  Still Canadian companies faced with a cross border competitive environment are facing a dilemma, especially in light of Canada's recently strengthening currency.

The Governor of the Bank of Canada may be forced to take action sooner rather than later, my guess is that the BoC is overestimating the output gap (BTW a very common occurrence from past empirical analysis), and is now realizing the scope of the problem.  they may be forced to act more quickly in raising interest rate only as a reflection of growing wage inflation, discounting exogenous factors (U.S., Europe and China) and deal with the problem at hand.

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