Inflation… still no chance

Couple months ago I posted a chart on inflation in Canada… even though interest rates have risen since the QE2 announcement, this hasn’t changed inflation expectations dramatically…

Here is the updated long-term chart of inflation expectations as implied by Real-Return bonds…

And here is the above data since the formal QE2 announcement (3-Nov-2010)… the green line is flat implying inflation expectations haven’t changed in Canada…

…although your daily bills (grocery, gas, insurance, etc) have only gone up! How does that add up? Paul Krugman does an excellent job of explaining core inflation (excluding food & energy) vs total inflation.

Update [7-Jan-2010]: Paul Amery at SeekingAlpha talks about (non-existent) inflation expectations globally

No Chance of Inflation in Canada – Long Term

Do you really think we are in inflation? When was the last time you paid for something that costs less than it did a year ago?… Never, that’s right… here is Canada’s historical inflation rate

If you want to know whether the bond market expects inflation or deflation, you don’t need to be a rocket scientist to figure out… it is very simple.

The implied or expected inflation rate is the difference between the yield on a nominal Government of Canada bond and the equivalent maturity real-return (see definition below) Government of Canada bond. The chart below clearly shows that markets expect inflation to hover in the 2% range in the long-term.

Real-return bonds are Government of Canada bonds on which the principal and coupon are adjusted based on the inflation rate as measured by the Consumer Price Index. If inflation is increasing, then the coupon and principal on a real-return bond increases proportionally.

Deflation means persistent negative year-over-year change in Consumer Price Index… from a historical perspective, Canada had 2 bouts of deflation – both during the Great Depression of the 1920s/30s.