Raising interest rates will help lower inflation in time, BoC governor says

Canada’s top central banker says the first of several rate hikes from the Bank of Canada is aimed at staving off a problematic economic scenario that could be more costly to households than the double-whammy of higher inflation and interest rates.

Speaking to reporters Thursday, Governor Tiff Macklem looked back a half-century ago to the economy of the 1970s.

He said during that time, consumers felt like they were being ripped off as prices rose and wages didn’t keep up — and labour strife followed. The economy doesn’t work well when people believe inflation will stay higher for longer, Macklem said.

To avoid a repeat of that scenario the bank must act to lower inflation through measures like Wednesday’s quarter-point rate hike, which shows Canadians their concerns are being taken seriously.

Inflation currently sits at a three-decade high and is set to rise further on the back of ongoing supply chain issues and rising global oil prices that make transporting goods and food even costlier.

As the pandemic eases, so too should the impact on supply chains, Macklem said.

2:03 Bank of Canada raises key interest rate

“Provided we keep inflation expectations well anchored, as those things work out, inflation should come down,” Macklem said during an afternoon press conference following his remarks.

“But if we let inflation expectations become unmoored, then when those supply constraints ease, inflation won’t come back down and it’ll be much more costly to get it back down. So that really, I think, outlines why that is a critical part of our thinking going forward.”

The Bank of Canada raised its target overnight rate to 0.5 per cent on Wednesday, increasing it from its emergency low by one-quarter of a percentage point.

Wednesday’s move marked the first increase since the Bank of Canada dramatically slashed the trend-setting rate to 0.25 per cent in March 2020 as a buttress against the economic fallout at the onset of the COVID-19 pandemic.

What has followed is an economic recovery. Macklem says after a solid end to 2021 when the economy grew at an annual rate of 6.7 per cent, the central bank now sees growth in the first quarter of 2022 to be stronger than previously forecasted.

The bank revised up its outlook for inflation, which is running at a three-decade high and is also hotter than the bank expected six months ago.

During a speech to the CFA Society Toronto, Macklem said higher oil prices have contributed to inflation by increasing transportation costs, which in turn up prices on consumer goods, including food. Grocery prices in January were up 6.5 per cent year-over-year.

There has also been a global shift during the pandemic from services to goods, which have been harder to come by through snarled supply chains that have pushed up everyday prices on a broader selection of everyday goods.

Macklem said this broadening in price pressures is a big concern and makes it more difficult for Canadians to avoid inflation, no matter how prudent they are as shoppers.

Although it can’t control global inflationary pressures caused by supply chains and Russia’s unprovoked invasion of Ukraine, Macklem said the increased borrowing costs, which is under its control, should to dampen spending growth.

That in turn will curb demand, keeping it from running significantly ahead of supply and further fuelling an already high inflation rate.

“For households and businesses that are already feeling the pinch of inflation, the higher cost of borrowing can be doubly painful,” Macklem said in his speech. “But tighter monetary policy is necessary to lower the parts of inflation that are driven by domestic demand.”

Macklem said the bank’s benchmark rate will need to rise further, including a potential for a half-percentage-point hike if senior decision-makers feel they need to move quicker or more forcefully.

He also said the central bank will eventually stop purchasing federal bonds as part of what’s known as “quantitative tightening” that will have the effect of putting further upward pressure on interest rates.