People pay for their items at a grocery store in Toronto, on Nov. 22, 2022. Carlos Osorio/Reuters
Canadian households may soon face steeper grocery and mortgage prices as a diesel and crude oil price “shock” reverberates across supply chains, according to a new report.
A record spike in diesel prices is rippling through the economy, creating inflation pressure that extends well beyond a typical move in crude oil, according to an Oct. 5 report by Olivier Gervais, Scotiabank’s director of modelling and forecasting.
Gervais described it as a structural product shortage rather than a standard crude oil supply issue. A key factor is the war in Iran, which has severely disrupted maritime shipping and transit through the Strait of Hormuz, creating a bottleneck for shipments of oil and refined products.
Geopolitical strains—including Ukrainian strikes on Russian energy infrastructure—have knocked out significant global refining capacity, which has further tightened international diesel inventories, the report said.
The sharp increase in diesel and oil prices are poised to fuel widespread inflation, driving up costs for virtually all goods and services, particularly food and housing.
“Diesel amplifies the inflationary impulse in both Canada and the United States,“ Gervais said in the report. ”Importantly, the effect is not confined to energy prices. There is evidence of pass-through to broader prices, with the effects appearing gradually in categories such as food and shelter.”
Diesel is vital to commercial transit, manufacturing, and farming, and that means consumers will feel these pressures heavily via a staggered “pass-through” effect, Gervais wrote.
The initial shock will be a jump in the cost of commercial freight, trucking surcharges, and direct transport, according to the report. Growing distribution and construction-material transport costs will then increase shelter prices within a year, while agricultural and transport expenses work their way through supply chains, ultimately triggering a secondary surge in grocery and food prices 18 months down the line.
“Diesel’s reach extends well beyond the pump,” Gervais wrote. “As a critical input into trucking, agriculture, construction and manufacturing, higher diesel costs spread through freight, production and distribution networks before ultimately reaching consumer prices.”
When diesel prices climb, businesses face mounting expenses, the report said. If they don’t absorb these increases or find ways to compensate, they typically transfer those extra costs directly to consumers.
Looking Ahead
Gervais noted that his analysis treats the diesel shock as temporary and does not completely capture what would occur if higher prices persist or begin to influence expectations.
“The inflation consequences could be meaningfully larger if firms and households come to expect elevated energy costs to last,” he said. “The longer the shock endures, the greater the likelihood that firms pass on higher costs more forcefully, inflation expectations become more sensitive and monetary policy is forced to respond more aggressively.”
The Bank of Canada tracks these risks as part of its core mission to maintain stable prices throughout the economy.
Gervais said the central bank can look past a temporary relative-price shock, but will be less likely to do so if the oil price increase begins to generate persistent or broad-based price pressures.
“The additional impulse from diesel makes that task harder: it adds to the risk that inflation spreads beyond energy and increases the pressure to raise rates to keep inflation expectations well anchored,” he wrote. “With upside risks beginning to accumulate, this new shock adds fuel to the fire.”
Inflation spikes as a result of these higher prices could pressure the bank to increase interest rates. That, in turn, would push up mortgage costs.
The Bank of Canada’s inflation-control range is 1 to 3 percent. Headline inflation has remained near the upper end of that range, in part reflecting higher energy costs. The Bank has said core inflation measures have remained relatively stable, which it cited as a factor in its decision to maintain the current policy rate.
According to Scotiabank, a prolonged diesel shock could increase inflationary pressures and require “a stronger monetary policy response.”
“For central banks, persistence is problematic. The Bank of Canada and the [U.S.] Federal Reserve can look through a temporary relative-price shock, but not one that spreads into broader inflation expectations,” Gervais said “With the diesel shock adding to an already widening set of upside risks, a sustained move would increase the pressure to raise rates more aggressively.”