Sticky inflation would warrant ‘much higher’ interest rates, BoC’s Macklem warns

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Bank of Canada hikes key interest rate to 4.25%
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The Bank of Canada’s rapid-fire interest rate hikes are starting to slow the economy, its governor said on Monday, and while the bank wants to avoid a recession, there is a risk sticky inflation will require “much higher” rates.

Speaking to business leaders in Vancouver, Governor Tiff Macklem said the tightening had “begun to work” but would take time to feed through the economy.

The bank lifted rates at a record pace of 400 basis points in nine months to 4.25 per cent — a level last seen in January 2008 — to tame inflation that stood at 6.9 per cent in October. That is more than three times the central bank’s target of two per cent.

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Going forward, the challenge is that raising rates too much would risk driving the economy “into an unnecessarily painful recession.” Not raising them enough would allow price increases to remain elevated and feed expectations for persistently high — or sticky — inflation.

“With inflation running well above target, this is the greater risk,” Macklem said. “If high inflation sticks, much higher interest rates will be required to restore price stability, and the economy will have to slow even more sharply.”

After last week’s 50-basis-point hike, the bank said it would monitor economic data to gauge whether rates need to rise further, adding it would still move forcefully if necessary.

“Decisions to raise the rate or to pause and assess the impact of past rate increases will depend on incoming data and our judgments about the outlook for inflation,” Macklem reiterated on Monday.

Reflecting back on a year in which prices spiked to a nearly four-decade high, Macklem said the bank had been surprised by more-persistent-than-expected supply problems, the Russian invasion of Ukraine, and a spike in demand after COVID-19 restrictions eased that prompted businesses to quickly lift prices.

Macklem also said future supply chains might be more resilient if they were shorter and more diversified, but they will be less efficient, and that could make the job of keeping inflation at the two per cent target harder.

“Over the long term, it seems likely that we won’t have the same disinflationary forces that we’ve had for the past 30 years. These potential developments could make it harder to bring inflation back to the two per cent target and keep it there,” Macklem said.

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Click to play video: 'Reaction and mortgage strategy following BOC rate hike'
Reaction and mortgage strategy following BOC rate hike

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