Bank of Canada Governor Tiff Macklem says that the path to avoiding a recession in Canada is “narrowing,” but that the central bank intends to keep raising interest rates even as the economy slows and risk of financial market instability increases.
Speaking to reporters from Washington after the annual meetings of the International Monetary Fund (IMF) and World Bank, Mr. Macklem said the Canadian economy is still overheating, with demand outstripping supply, and that the labour market needs to weaken to restore price stability.
“At this point, there isn’t a trade-off here. We need to cool the economy, and we need to get inflation down,” Mr. Macklem said, reiterating the central bank’s intention to raise interest rates again on Oct. 26.
The governor’s hawkish comments come at the end of a week defined by gloomy growth forecasts, turmoil in British bond markets and worrisome inflation data from the United States.
The IMF warned there will be a sharp slowdown in global economic growth next year, and that a “mild recession could easily emerge” in Canada. Meanwhile, another month of scorching inflation data from the U.S. published on Thursday all but guaranteed the Federal Reserve will continue its aggressive pace of hikes in interest rates.
Mr. Macklem said the mood in Washington was one of caution. But he said policy makers were committed to getting inflation under control, despite the short-term costs to economic growth and employment this could entail.
“There was a broad consensus that inflation remains the most immediate threat to current and future prosperity,” Mr. Macklem said.
The Bank of Canada’s own rate hikes – five consecutive moves since March – are already squeezing the economy, particularly rate-sensitive sectors, such as housing. The Canadian Real Estate Association said on Friday that national home sales fell 3.9 per cent in September compared with the previous month, while the national home price index declined 1.4 per cent.
Nonetheless, Mr. Macklem said more needs to be done to bring demand back in line with supply, particularly in the labour market, where job vacancies are high and businesses are struggling to find workers. Higher borrowing costs will slow down business activity and reduce demand for workers. The bank also needs to make sure that Canadians do not start expecting permanently higher inflation, he said.
“We’ve been very clear with Canadians that we are taking forceful action to get inflation to target. Canadians have demonstrated confidence, and inflation expectations have remained reasonably well-anchored on our target. But we’re not inclined to test Canadians’ patience,” he said.
Getting inflation back to the annual growth target of 2 per cent will require a period of slower economic activity, although not necessarily a recession, Mr. Macklem said.
Bank of Canada officials have long maintained that a so-called soft landing is still possible, where inflation comes down without a major spike in unemployment or sharp economic contraction. That said, Mr. Macklem sounded less sure of this narrative on Friday.
“That path to a soft landing does depend on a number of key factors, and that path is narrowing,” he acknowledged. “The longer global supply issues remain, the longer the war in Ukraine creates uncertainty, the more volatility we’re seeing in energy prices, and the stickier inflation is, the narrower that path gets.”
Royal Bank of Canada chief executive officer Dave McKay said in a separate appearance in Washington on Friday that central banks are “doing the right things” to fight inflation, but that companies are suffering the consequences because those same central bankers were too late in responding to the inflation threat.
“I think the fire truck has left the station, but it’s a multifire drill here. ... We saw this coming in 2021. We should have got ahead of the curve,” Mr. McKay said at an annual meeting held by the Institute of International Finance.
The fallout is manifesting in the decisions CEOs are making about wages in an environment where unemployment is low and job openings are plentiful in spite of fears of a recession, Mr. McKay said.
“The average CEO, 65 per cent of CEOs, think that salary increases, compensation increases will be 5 per cent or a little more next year,” he said. “So we’re about to make that dangerous wage inflation spiral decision right now. That’s why being late to the fire is so damaging to the economy.”
Alongside concerns about inflation and growth, policy makers are paying increasing attention to pockets of instability that are emerging in financial markets as central banks raise interest rates.
This was on prominent display in recent weeks in Britain, where the announcement of tax cuts spurred a major sell-off in government bonds by pension funds. The Bank of England was forced to intervene to shore up the market.
Mr. Macklem said the impact of higher interest rates on global financial markets has generally been orderly. But central bankers “need to be vigilant” to the possibility of significant disruptions in certain financial markets.
The Bank of Canada is “making sure we’re prepared to use our tools… to manage these risks should they arise, as the Bank of England has been doing this week, or last couple of weeks,” he said.
He offered few clues about how high the central bank intends to raise interest rates. The policy rate is currently at 3.25 per cent. Most private-sector forecasters expect the bank to announce a half-point increase later this month.
How big the bank decides to go could be determined by data next week. The Bank of Canada will publish a pair of surveys on Monday that will show whether consumers and businesses expect inflation to continue rising. Statistics Canada will publish September consumer price index data on Wednesday.
With a report from James Bradshaw