The Price is Wrong:

With the Canadian dollar charging to parity for the first time since November 1976, we have completed a study on how Canadian retail prices have responded to the loonie’s historic run. The main conclusion stands: It may be a Brave New World for the Canadian dollar, but the Song

Remains the Same for the most part for consumers. While we have discovered some fractional narrowing in the prices of some goods over the past three months, the currency’s latest sprint has completely offset those modest moves. Thus, we find that the average price gap on a basket of assorted goods is now roughly 24% at today’s exchange rate—that is, Canadian dollar prices are 24% higher than U.S. dollar prices on identical goods. While it is unrealistic to expect prices to instantaneously adjust across the board to a currency move, this is nevertheless an unsustainable gap. Given that no-one requires a calculator to make these comparisons, the pressure up and down Canada’s supply chain to bring these prices into closer alignment is bound to intensify immensely in the months ahead. This ultimately should help keep a check on consumer price trends, and will thus further reduce the need for much additional Bank of Canada tightening down the line when the current credit market turmoil passes.

The unprecedented 60% surge in the Canadian dollar over the past five years has produced plenty of pain for the country’s manufacturing base, yet has created very little joy for the average consumer. Retail prices in Canada have responded to the loonie’s moonshot with all the speed and alacrity of a three-toed sloth on a hot summer’s day. Canadian prices on many directly comparable goods have been achingly slow to respond to the major shift in the

exchange rate, and, in some cases, appear far out of line with their U.S. counterparts. The most widely-cited example of this yawning gap is typically on books, where retailers are scrambling to address the deep divergences between U.S. and Canadian prices. However, the spread on book prices only stands out because of the ease of comparison—many, many other products are at least as far out of whack.

Table 1 compares identical products sold through similar retail channels, and does not include taxes or other charges.

The striking aspect of the comparison between Canadian and U.S. prices on these goods is the near total consistency with which Canadian prices are well above their U.S. equivalents at today’s exchange rate. Now, it’s asking far too much to expect prices to adjust instantaneously to exchange rate changes, so we converted Canadian prices at the average loonie over the past year (89 cents or US$1.121).

But, even using this low bar, Canadian prices are roughly

11% higher than their U.S. counterparts in single-currency

terms. Using today’s exchange rate instead yields some

massive price gaps between the two countries (an average

of 24%), and at the very least suggests there should be

some discounting ahead in Canada.

Note that there are some cases where the price in Canada is

about “right”—such as a cup of Tim Horton’s coffee, Apple

iPods and iTunes—but those examples are the exceptions.

And, returning to the book example, the recent release of

Alan Greenspan’s memoirs (“The Age of Turbulence”) shows

that there is still a wide discrepancy—the U.S. discounted

price is US$20.99 versus $26.46 in Canada, a 26% gap.

According to second-hand sources, price gaps on high-end

goods are typically wider yet. Even the Blackberry Curve can

be often found at US$450 in the U.S. versus typically C$599

here, a 33% spread. Perhaps most close to home, a large

double-double from Tim Horton’s runs $1.35 here and

US$1.29 in East Aurora New York, a modest 5% gap.

There are some important policies and economic implications

of the slow-motion pace to price reductions in Canada:

1) Canadian inflation is higher than it should be. Among

major industrialized economies, Canada now has the highest core CPI inflation rate

at 2.2%, recently pushing above the U.S. pace . This simply

should not be the case. Among these same economies, Canada has seen the

steepest rise in its trade-weighted exchange rate in the past five years, and it is also

one of the most open economies. Taking these two factors into account gives a

rough guide to how much domestic prices should have been affected by currency

trends in recent years, and by that standard Canada would typically have seen the

most downward pressure on prices.

2) Canadian interest rates could be even lower. If consumer prices had reacted even

a little more forcefully to the loonie’s steep ascent, core inflation would likely be

below the Bank’s 2% target, and officials would not

have hiked rates in July. Canadian CPI inflation for

goods has been running on average 1% below its U.S.

counterpart for the past three years. That’s a

tidy sum for sure, but well below what one may have

expected given the average increase of 8% annually in

the currency over that time frame.

3) Cross-border shopping may be poised to grind higher

again. There have been a number of developments

blocking a repeat of the last great wave of cross-border

shopping in the early 1990s. For instance, many major

U.S. retailers have since planted roots in Canada, and

border delays/hassles and rising pump prices have

dissuaded Canadians from making the trek. But at the

same time, tourist personal limits have been increased

(to $400 from $200 for 48 hours) and the price gaps are as wide as ever. It may be

only a matter of time before the cross-border shopping dam bursts again. It

may already be happening on-line.

The Bottom Line: Canadian consumers are far from reaping the full rewards of the

massive run-up in their currency in the past five years. This is keeping inflation higher

than it otherwise should be, contributing to the upward pressure on interest rates. If

Bob Barker was still on the job, he would likely say, “Canadian retail prices, come on

down!”, and Canadian consumers should too.