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News that Sobeys Inc. is demanding that suppliers cut their prices is the latest sign of what remains broken – if you can call it that – in Canadian consumer inflation. The recovery from the 2008-09 recession has been at its core a cost-cutting recovery, and that's a key reason why inflation stubbornly refuses to do what monetary policy wonks say it's supposed to do. Now, with Sobeys upping the ante in the country's heated retail price wars, this could continue to befuddle central bankers for some time yet.

Sobeys, fresh off an acquisition of Safeway Inc.'s Canadian stores that gives it much more heft in the national grocery marketplace, sent a letter to its suppliers on Dec. 24 telling them they must cut their prices to the retailer by 1 per cent. The letter also advised that Sobeys won't accept any price increases from them in 2014. Merry Christmas.

It's a symptom of the cutthroat competition in Canada's retail sector, brought on by the aggressive expansion of big-scale U.S. department stores such as Target and Wal-Mart, whose laser-focus is on low prices and capturing market share. Canada's home-grown retailers have been trying to keep up both by increasing their scale and bargaining power with suppliers (through acquisitions such as Sobeys/Safeway and Loblaw Cos.' purchase of Shoppers Drug Mart Corp.), and by cutting prices.

For consumers, it's great; for the Bank of Canada it's problematic. Even as Canada's employment has grown and the output gap (the difference between actual economic output and the economy's full capacity) has narrowed – factors that would normally accelerate inflation – price growth has slowed. Canada's consumer price index (CPI) inflation for November (the latest data) was running at just 0.9 per cent year over year, below the central bank's 1-to-3-per-cent target band.

In an interview with CBC this week, Bank of Canada Governor Stephen Poloz identified the disinflationary trend as his biggest concern. "It's a difficult one to explain right now – and that always makes me worried," he said.

A worry, but not necessarily a problem. If, as the bank believes, the retail wars are the chief cause, "that should be transitory," he said.

"The kind of falling prices we see in retail right now are actually a positive thing, because it gives more income [to consumers] for spending in the economy. This is what we call positive deflation, or good deflation," he said.

"But the concern would be if it lasted a long time and began to affect expectations, which up until now have remained anchored at our 2-per-cent target rate. That guides companies in their actual decisions around wages and their own prices. Without that kind of anchor, you run the risk of falling into a very low-inflation environment, possibly deflation."

By Mr. Poloz's own reckoning, this retail-driven disinflation is "taking longer to go away than we expected." And with Sobeys launching a new round of cost (and presumably price) cuts for 2014, likely pressuring Loblaw and other competitors to do the same, the price wars are clearly far from over.

The danger of disinflation contagion is not hard to see. Suppliers, their profit margins squeezed, will pass the pain on to their suppliers, and on up the line. Companies of all stripes will conserve and resist hiring and wage increases. Toss in Canadian consumers who already have heavy debt burdens that may weigh on their capacity to spend, and it's not a great recipe for sustaining an economic recovery.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 4:00pm EDT.

SymbolName% changeLast
L-T
Loblaw CO
-0.92%150.1
MRU-T
Metro Inc
-0.56%72.72
T-N
AT&T Inc
+0.28%17.6
T-T
Telus Corp
+0.37%21.67
TBB-N
AT&T Inc 5.350% Global Notes Due 2066
-2.65%23.5
TGT-N
Target Corp
+1.45%177.21
TU-N
Telus Corp
+0.63%16.01
WMT-N
Walmart Inc
-0.91%60.17

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