There was plenty to celebrate this month as inflation—measured as the consumer price index basket—hit 2% year-over-year growth in August. We haven’t seen that in more than three years, and many had worried we wouldn’t be able to get back to 2% at all in a new post-pandemic world full of supply shocks, inflationary demographics and heightened geopolitical tensions. Fast forward to 2024 and not only has 2% clearly arrived, but Bank of Canada governor Tiff Macklem is flagging risks that price growth might run below the bank’s target (we agree).

Still, we aren’t exactly ready to throw up the confetti just yet, even though there’s much to celebrate relative to the worse outcome of persistent and high inflation.

For one, the composition of what’s driving prices looks very different now than it did before the pandemic, and in some ways, it is less healthy for the economy. Two-thirds of the growth in inflation in August came from surging mortgage interest rate costs and higher home rents compared to 2% on average in the decade before the pandemic. Growth in mortgage costs will slow as the BoC continues its cutting cycle, but the structural shortage of housing relative to rapid population growth will keep a floor under home and rent prices. Meanwhile, even though food price growth is slowing, grocery prices are still up 25% from before the pandemic. For many Canadians, especially lower-income families, housing and food prices remain the most critical categories for price growth. One could argue that 2019’s 2% inflation was a more favorable composition than 2024’s 2%.

Second, for most Canadians, it isn’t the annual increase in prices that weighs heavily on them. It’s the historic increase in price levels within the past five years that stays front of mind. Prices are 17% higher than they were the month before the pandemic, and 2% inflation means they are still climbing, just at a slower pace. In the U.S., prices are similarly 21% higher. Wages have been catching up—average hourly earnings are also up 18% from pre-pandemic levels in Canada. But this weighs on central bankers who worry that interest rates could stay too high for too long, causing wage growth to slow again when prices are still very high for consumers.

Third, while a good deal of the decline in prices so far has come from the unwinding of pandemic-related shocks, the downward pressure on inflation ahead is likely to come from more painful places in the economy. In Canada, job openings are falling and the unemployment rate is rising—already a percentage point above pre-pandemic levels. Household savings are still high, but concentrated at the top end of the income scale and going into term investments that are unlikely to be spent in the near term. With households stretched by a high cost of living and softening labour markets, disinflationary forces will be symptoms of a struggling economy, instead of a “normalization.” The silver lining is that the BoC will likely have plenty of room to lower interest rates and help keep a lid on rising unemployment.

Frances Donald is Senior Vice President and Chief Economist at RBC.

Nathan Janzen is an Assistant Chief Economist, leading the macroeconomic analysis group. His focus is on analysis and forecasting macroeconomic developments in Canada and the United States.

Abbey Xu is an economist at RBC. She is a member of the macroeconomic analysis group, focusing on macroeconomic forecasting models and providing timely analysis and updates on economic trends.

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