Inflation will stay low as economic recovery weighed down by business losses, Stephen Poloz says

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Former Bank of Canada governor Stephen Poloz expects that the economic recovery from COVID-19 will be weighed down by businesses that are rendered permanently damaged by the pandemic, putting him in the camp of observers who believe that a muted K-shaped recovery is under way, where the economy is divided between parts that rebound and parts that struggle.

“Even if the economy is growing, it still feels like a recession to a lot of people,” Mr. Poloz said.

Mr. Poloz, now a special adviser with law firm Osler, Hoskin & Harcourt, gave his remarks during an online session of the Portfolio Management Association of Canada’s 2020 National Conference, outlining an economy defined by many of its current attributes – including low interest rates, low inflation and low oil prices.

Parts of the economy, such as travel, hospitality and in-person retail could struggle with changes in the way people interact with businesses and each other, making the recovery potentially very different from others in recent times.

“This time, people have learned some things that will likely result in permanent behavioural change,” he said.

His remarks come after upbeat test results from pharmaceutical firms developing COVID-19 vaccines, which has sent major stock benchmarks surging over the past two weeks on a wave of optimism that the pandemic could enter its final stages as vaccines are widely distributed next year. The S&P 500 hit a record high on Monday, implying that investors are betting on a full recovery in corporate profits next year as the pandemic recedes.

Mr. Poloz acknowledged to his audience that parts of the economy are enjoying a quick rebound. Retail sales, for example, have fully recovered, helped in part by government benefits. And overall economic activity stands at about 96 per cent of prepandemic levels, with employment also rebounding from lockdown lows in March and April toward levels before the pandemic.

But overall unemployment levels, he said, will likely remain elevated for some time owing to permanent losses in parts of the economy, as workers move from flat or struggling sectors to growing sectors over time.

“Given this, the bottom part of the K dragging demand down for a long time, leads to the conclusion that inflation will stay low. That’s a natural conclusion to reach,” Mr. Poloz said.

“It could even become deflation in a really long, drawn-out scenario,” he said.

But he believes that the economy can avoid the worst pitfalls if it remains roughly balanced between supply and demand. For example, if people fly less they may spend the money they save on renovating their kitchens.

“Will holding interest rates low for longer induce more people to eat in restaurants or fly on airplanes? I think the answer is obviously not. But what it will do is put even more pressure on housing, renovations and all those parts of the economy – and that will draw workers into those sectors over time,” Mr. Poloz said.

One unknown is how government responds to the huge debt loads it has assumed during the pandemic. Though tax increases are a possibility, Mr. Poloz says he believes that governments can avoid significant tax hikes by focusing on economic growth instead.

“There are lots of things governments can do to reduce the impediments to growth, such as interprovincial free trade,” he said. “Why wouldn’t we just do that?”

If Mr. Poloz wasn’t embracing hopes for a full-on V-shaped economic recovery, David Rosenberg, chief economist at Rosenberg Research & Associates, was even more skeptical.

He expects that the arrival of effective vaccines has already been factored into most market forecasts for 2021, making the current stock market rally look stretched. And with the U.S. economy now facing a spike in COVID-19 infections, partial shutdowns and rising consumer savings, he believes that a dip back into recession is a strong possibility.

“Between now and the vaccine being distributed, I know one thing: We will be staring an economic relapse in the face,” Mr. Rosenberg said.

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