INFLATION AT ALMOST TWO-DECADE HIGH COMPLICATES BANK OF CANADA RATE PLAN
Statistics Canada’s consumer price index (CPI) increased 4.4 per cent from September 2020, the biggest year-over-year increase since the CPI surged to 4.7 per cent in February 2003. The index rose 0.2 per cent from August, matching the previous monthly increase, as all the categories that the agency uses to arrange its CPI basket posted gains, led by transportation, shelter and food.
Prices are being driven higher around the world by an extreme mismatch between supply and demand. Factories everywhere were idled in the early months of 2020 to slow the spread of COVID-19, and also in anticipation of a long recession. But unlike previous recessions, demand never really went away, because governments offset health lockdowns with unprecedented rescue packages. Suppliers are now scrambling to catch up, clogging ports and other transportation lanes that are dealing with their own pandemic-related issues.
Central banks that set interest rates to keep inflation at a moderate pace have been forced to think hard about whether they can keep interest rates near zero for much longer. That includes the Bank of Canada. Governor Tiff Macklem would like to leave considerable stimulus in place because relatively high jobless rates indicate that the economy remains weaker than it was before the crisis.
“Slack in the labour market remains,” Macklem told reporters last week. “Low-wage workers are well below their pre-pandemic level, whereas other workers have recovered, so there still is some space there.”
Jimmy Jean, chief economist at Desjardins Securities Inc., this week advanced his estimate of when the Bank of Canada will raise interest rates to July, from October. Bloomberg News reported that the price of financial assets tied to short-term borrowing costs implies that investors think Canada’s benchmark interest rate will move higher in the first part of 2022.
Those forecasts represent a challenge to the Bank of Canada, which has since last year insisted that it intends to leave its benchmark rate unchanged until at least the second half of 2022 to guarantee a “complete” recovery from the COVID-19 recession.
“Lift off may not come as early as markets are currently pricing, but the risks are certainly moving to sooner rather than later,” said James Marple, an economist at Toronto-Dominion Bank.
Milder core inflation could provide some comfort to central bankers.
Macklem and his deputies will release the results of their interest-rate discussions on Oct. 27. They will probably opt to further reduce their weekly purchases of Government of Canada bonds, an aggressive form of monetary policy that is no longer needed, as the economy is on track to post strong growth over the second half.
But the Bank of Canada will likely need more evidence to back off its plan to keep the benchmark interest rate at 0.25 per cent until at least the second half of next year. Inflation is running alarmingly hot at the moment, but deflation was the bigger worry only a year ago.
Some academic economists argue that central banks have set artificial ceilings for economic growth over the years by moving too quickly to keep inflation below their targets. The CPI averaged year-over-year growth of 2.1 per cent from the start of 2018 to the end of 2019, and averaged 1.9 per cent between January 2018 and September.
Macklem has some room to manoeuvre, provided he can keep expectations from spiralling out of control over the next few months, since that could make inflation a self-fulfilling prophecy. The Bank of Canada’s latest quarterly survey of consumer expectations reported that respondents see inflation climbing to 3.7 per cent over the next 12 months, and then decelerating to about three per cent over the next two years.
“We do not see anything in the September CPI report that would convince the BoC that a more hawkish stance on policy would be warranted at the October meeting,” said Veronica Clark, an economist at Citigroup Global Markets Inc. “A few more months of inflation and labour market data have potential to raise concerns over persistently stronger inflation, but we expect the BoC would wait to see this data before shifting policy.”
Story by: Financial Post