Kevin Carmichael: Bank of Canada's big worry is stopping rising prices from becoming a self-fulfilling prophecy
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Inflation is nearing its fastest pace since the Bank of Canada began using the consumer price index to set interest rates in the early 1990s, increasing the odds that the central bank will raise borrowing costs early in the new year.
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The CPI surged 4.7 per cent in October from a year earlier, compared with a year-over-year gain of 4.4 per cent in September, Statistics Canada reported on Nov. 17. The CPI also increased 4.7 per cent in February 2003, which had stood alone as the biggest increase since a 5.5 per cent gain in October 1991, a moment when the Bank of Canada was nearing the end of a successful fight against a wave of price increases that peaked around seven per cent earlier that year.
Back in 2003, when annual CPI increases neared five per cent, then governor David Dodge opted to raise interest rates the following month, observing in a statement that “persistent above-target inflation rates over the past few months reflect not only the impact of higher-than-expected crude oil and natural gas prices, but also continuing increases in auto insurance premiums and price pressures in certain sectors such as housing, food and some services.”
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The same could be said of current conditions. October marked the seventh month in a row that headline inflation ran hotter than three per cent, the high end of the Bank of Canada’s comfort zone, while year-over-year increases in the CPI exceeded three per cent for six consecutive months through March 2003. Now as then, the main sources of upward price pressures are crude, natural gas, housing, food and some services.
Yet what to do about inflation remains a dilemma for Bank of Canada governor Tiff Macklem despite the alarming jump in the CPI, because various labour-market indicators suggest the economy remains weak, justifying the benchmark interest rate’s current setting of 0.25 per cent. The biggest driver of the CPI’s latest surge was a 42 per cent increase in gasoline prices, which are being stoked by a severe mismatch between supply and demand in global energy markets. There’s nothing the Bank of Canada can do about that.
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In theory, cost increases that are the result of shortages of inputs such as oil and computer chips should subside as suppliers rush to fill demand. Therefore, the best cure for current conditions is probably patience.
“While our analysis continues to indicate that these pressures will ease, we have taken them into account for the dynamics of supply and demand,” Macklem said in an op-ed published by the Financial Times earlier this week. “What our resolve does mean is that if we end up being wrong about the persistence of inflationary pressures and how much slack remains in the economy, we will adjust.”
Subtract energy from the CPI basket of goods and services and the increase from October 2020 was 3.3 per cent, the same year-over-year gain that was posted in September, Statistics Canada said. That’s still hotter than the Bank of Canada would like, but suggests that underlying price pressures probably aren’t as severe as the headline number makes them out to be. The average of three measures of “core” inflation that the Bank of Canada follows to assess price trends was 2.7 per cent, a reading that falls within the central bank’s comfort zone for inflation of one per cent to three per cent.
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“Changes in domestic monetary policy — although arguably important for signalling reasons — won’t alleviate inflation pressures that are global in nature,” Karl Schamotta, chief market strategist at Cambridge Global Payments, said in an email to clients. “Ebbing supply chain issues, falling commodity prices, and lower levels of fiscal support are likely to prove more important over the year ahead.”
Macklem would look through the recent burst of inflation if not for concern about what the outsized readings will do to expectations of where prices are headed. He and his deputies last month opted to end their bond-buying program and advance by three months their timeline for their first post-pandemic interest-rate increase. The main reason for those moves was to keep inflation from becoming a self-fulfilling prophecy, whereby workers start demanding higher wages and suppliers begin raising prices in anticipation of permanently higher costs.
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That’s a legitimate concern. All the major components of Statistics Canada’s CPI basket increased in October, led by a 10 per cent jump in transportation costs, which capture energy prices. Shelter costs increased 4.8 per cent and food costs rose 3.8 per cent from October 2020. Both those gains were roughly the same as the previous month.
“The recovering economy and hot inflation will likely prompt the Bank of Canada to react and raise interest rates sooner rather than later,” said Ksenia Bushmeneva, an economist at Toronto-Dominion Bank. “We expect the Bank of Canada to start raising its key interest rate in April of 2022, but cannot rule out the possibility the central bank will act earlier if the job market remains resilient and inflation keeps surprising to the upside.”
• Email: kcarmichael@postmedia.com | Twitter:
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