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Bank of Canada Governor Tiff Macklem participates in a news conference at the Bank of Canada in Ottawa on Dec. 15, 2021.Justin Tang/The Canadian Press

Bank of Canada Governor Tiff Macklem said the pace of interest rate increases this year will depend to a significant extent on how quickly consumers run down excess savings they have built up over the course of the pandemic.

The central bank estimates that the average Canadian saved thousands of extra dollars since early 2020, with people spending less on vacations, restaurants and live entertainment. What households do with those savings could determine how hot the economy gets this year, and how hard the Bank of Canada will need to step on the brakes to get inflation back under control.

“It’s clear that interest rates need to be on a rising path. The slope of that path is going to depend on economic developments, and if consumers spend more, the slope of that path will likely have to be steeper,” Mr. Macklem told the Senate’s standing committee on banking, trade and commerce on Wednesday.

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Mr. Macklem made the virtual appearance before the committee after a crucial policy decision last week, where the central bank’s governing council removed the last of its emergency response measures, forward guidance, and told Canadians to prepare for the first rate hike since 2018. Analysts widely expect the bank to start raising interest rates at the next policy meeting on March 2, and most expect at least three rate increases this year.

This shift in monetary policy last week came in the face of surging inflation, which hit a three-decade high of 4.8 per cent in December. It also followed a stream of data releases showing the economy is now operating at full capacity, with employment back to prepandemic levels and gross domestic product growing rapidly.

Mr. Macklem used his appearance to underline that monetary policy is at a crossroads and needs to change. The bank has been holding its key policy rate at 0.25 per cent since early in the pandemic.

“The economy is growing strongly, interest rates are at all-time lows, our balance sheet is bigger than it’s ever been, it’s time to start normalizing,” he said.

The bank published new projections for inflation last week showing the annual rate of consumer price index growth will likely remain close to 5 per cent through the first half of the year, before returning to around 3 per cent by the end of the year.

Mr. Macklem said he expects inflation to decline as problems with global supply chains begin to normalize and consumer demand shifts back toward services and away from durable goods. However, he noted this projection remains uncertain.

“Inflation could actually come down faster, particularly if there’s some price reversal,” he said, noting that the bank’s forecast assumes prices stop rising so rapidly, but don’t drop back to prepandemic levels.

“That’s balanced against the risk that some supply chain issues could be longer lasting. The virus is still out there. It’s possible that Omicron affects production facilities in other parts of the world,” he said.

When it comes to consumer spending, the bank estimates that Canadians will spend around 20 per cent of their excess pandemic-era savings over the next few years. Here again, Mr. Macklem acknowledged this projection could be wrong in either direction.

“There are also risks that consumers actually save more of their accumulated savings. So far, even with the strength we’ve seen in consumption, they actually have not been dipping into that excess savings, it’s still actually building up,” he said.

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