A commodities rally sparked by Russia’s invasion of Ukraine will push Canadian inflation higher for longer, with the headline rate now seen peaking at or above 6%, forcing the central bank to raise interest rates more aggressively, economists told Reuters.
Canada’s inflation rate has already surged well above the 5.1% that the Bank of Canada forecast for the first quarter in January, highlighting the tough road ahead to get price growth back down to the 2% target.
Graphic: Canada’s annual inflation rate: https://graphics.reuters.com/CANADA-ECONOMY/INFLATION/egpbkqrxrvq/chart.png
The central bank will have to balance efforts to tamp down on soaring prices against the risks that spiraling levels of mortgage debt could make Canada’s economy more sensitive to interest rate hikes than before the coronavirus pandemic.
Some investors worry that the BoC could cut short the economic expansion if it tightens too fast.
A Reuters survey of economists at five leading financial institutions and a consultancy showed that most now expect the Bank of Canada to hike borrowing costs four to five times in 2022, lifting its policy rate to 1.25% or 1.5% by the end of the year. Scotiabank is forecasting a year-end policy rate of 2.5%.
Canada’s latest inflation data on Wednesday surprised on the upside, with the Consumer Price Index hitting a new 30-year high of 5.7% in February. The jump was driven by broad gains across all sectors.
All six economists surveyed now see inflation peaking at or above 6% in the coming months, with their year-end forecasts ranging from 3.3% to 5.8%. The BoC in January forecast fourth-quarter inflation of 3.0%.
“The commodity price increases that we have seen in the past couple of weeks – that’s something that a central bank would normally want to look through,” said Josh Nye, a senior economist at RBC Capital Markets who was among those surveyed.
“But with inflation already so far above the Bank of Canada’s target, they’ve said they’re more concerned about upside surprises than they are about downside surprises on inflation.”
The central bank raised its policy rate to 0.50% from 0.25% this month, its first increase in three years. Bank of Canada Governor Tiff Macklem said more rate hikes were coming and he left the door open to a rare half-percentage-point increase.
Money markets see a roughly 50% chance of the larger rate increase when the central bank issues its next policy decision on April 13. It has been almost 22 years since Canada saw a 50-basis-point rate hike.
The conflict in Ukraine and ensuing sanctions on Russia have played havoc with global supply chains, sending prices of many key commodities higher. Russia is one of the world’s biggest energy producers, and both it and Ukraine are among the top exporters of grain.
Nye estimated the surge in oil prices since late February on its own will add about three-quarters of a percentage point to Canada’s CPI.
U.S. inflation is expected to average 7.7% this quarter, according to a Reuters poll of 69 economists last week, up from the 7.1% forecast in February.
With Canada’s economy firing on all cylinders, its central bank must now act forcefully on interest rates to tame price surges, said Derek Holt, head of capital markets economics at Scotiabank.
“Given how far behind the inflation curve the Bank of Canada finds itself, they need to do something more convincing in order to demonstrate that they are serious about their inflation mandate,” said Holt, who also participated in the survey.
Still, the central bank will need to take into account the potential that war will slow global economic activity, while also balancing the inflationary pressures coming from supply shortages due to the latest COVID-19 restrictions in major Chinese manufacturing hubs.
“There is the probability of renewed supply chain issues in other goods that will also keep inflation more elevated than we previously anticipated,” said Andrew Grantham, a senior economist at CIBC Capital Markets who was among those surveyed.
Graphic: Forecasts for Canadian interest rates: https://graphics.reuters.com/CANADA-ECONOMY/INFLATION2/mypmnxdnnvr/chart.png
(Reporting by Julie Gordon in Ottawa; Editing by Denny Thomas and Paul Simao)
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Given high inflation, slowdown in Canada’s economy is ‘a good thing,’ Tiff Macklem says
Bank of Canada governor Tiff Macklem says that although a slowing economy may not seem like a good thing, it is when the economy is overheated.
Speaking in Quebec City on Tuesday, Macklem said that higher interest rates are working to cool the economy as elevated borrowing costs are constraining spending on big-ticket items such as vehicles, furniture and appliances.
As demand for goods and services falls, Macklem says the economy will continue to slow.
“That doesn’t sound like a good thing, but when the economy is overheated, it is,” he said.
In addition to global events, the overheated domestic economy pushed up prices rapidly, he said.
To slow the economy domestically, the Bank of Canada has embarked on one of the fastest monetary policy tightening cycles in its history. It has hiked its key interest rate eight consecutive times since March, bringing it from near-zero to 4.5 per cent.
However, last month, the Bank of Canada said it will take a “conditional” pause to assess the effects of higher interest rates on the economy.
“Typically, we don’t see the full effects of changes in our overnight rate for 18 to 24 months,” Macklem said on Tuesday.
“In other words, we shouldn’t keep raising rates until inflation is back to two per cent.”
However, the governor said the Bank of Canada will be ready to raise rates further if inflation proves to be more stubborn than expected.
As gas prices have fallen and supply chains have improved, inflation in Canada has slowed since peaking at 8.1 per cent in the summer. Macklem called this a “welcome development,” but stressed inflation is still too high.
“If new data are broadly in line with our forecast and inflation comes down as predicted, then we won’t need to raise rates further,” Macklem said.
For inflation to get back to two per cent, Macklem said wage growth will have to slow, along with other prices.
Wage gains lagging inflation
Wages have been growing rapidly for months but continue to lag the rate of inflation. In December, wages were up 5.1 per cent.
Though annual inflation is still at decades-high levels, economists have been encouraged by a more noticeable slowdown in price growth over recent months.
The Bank of Canada forecasts the annual inflation rate will fall to three per cent by mid-year and to two per cent in 2024.
Royce Mendes, an economist with Desjardins, said that Macklem is crossing his fingers that the rate hikes he has implemented so far will be enough to get it done.
“The head of the Bank of Canada seems quite comfortable sitting on the sidelines even as his U.S. counterpart will be discussing the need for further monetary tightening south of the border,” Mendes said.
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