Bank of Canada Governor Tiff Macklem said in a TV interview broadcast on Sunday that high inflation will be “transitory but not short-lived,” giving additional insight into the central bank’s thinking a week after it raised its inflation projections and shifted toward a more aggressive timeline for tightening monetary policy.
Central bankers, including Mr. Macklem, spent much of the spring and summer arguing the current high annual rate of inflation was a short-term phenomenon, driven by statistical quirks and supply-chain bottlenecks that would clear over time. In recent months, rising energy prices and continuing supply-chain congestion have forced Mr. Macklem and his team to change their narrative around inflation and move more quickly toward ending pandemic-era stimulus, which has kept interest rates at rock bottom to boost consumer price growth.
“I think transitory, to economists, means sort of not permanent,” Mr. Macklem said in an interview that aired on CTV’s Question Period. “I think to a lot of people, transitory means it’s going to be over quickly. … I don’t know exactly what the right word is, but it’s probably something like, ‘transitory but not short-lived.’”
Mr. Macklem pointed to the bank’s latest inflation projections, published on Oct. 27, which show the annual rate of inflation rising to close to 5 per cent for the remainder of the year, before dropping to around 2 per cent by the end of next year. The bank now expects inflation to average 3.4 per cent for the whole of next year, a full percentage point higher than its previous projection, from July. Inflation hit an 18-year high of 4.4 per cent in September.
The Bank of Canada has been one of the most aggressive advanced-economy central banks in winding down stimulus and signalling rate hikes. In its Oct. 27 rate decision, the bank ended its quantitative easing program, which had been used to hold down longer-term interest rates, and brought forward the timeline for a potential interest rate hike to the middle quarters of next year. That raises the possibility that the bank could raise its policy rate as early as April.
At a news conference after the rate decision, Mr. Macklem said there are few signs, in either wage growth or inflation expectations, that the current bout of high inflation is becoming entrenched. But he acknowledged the supply-chain problems that are pushing up consumer prices are “more severe and more persistent” than the bank had expected.
“The big question is how long these supply-chain bottlenecks are going to last, and how long are energy prices going to be surging, and nobody really has a good insight into that,” National Bank of Canada rate strategist Taylor Schleich told The Globe and Mail.
“Everyone’s just kind of assuming that maybe midway through next year these things start to ease and inflation comes down. But nobody really knows, and I think that’s being reflected in central bank communications; they’re just not entirely sure,” Mr. Schleich said.
Mr. Macklem’s Sunday appearance on CTV followed an important week for central banks around the world.
On Wednesday, the U.S. Federal Reserve announced it would reduce its pace of asset purchases by $15-billion a month, the first step in winding down a massive stimulus program launched early in the pandemic. At the same time, however, Fed chair Jerome Powell indicated the U.S. central bank would remain patient on rate increases because of continuing labour market uncertainty.
The following day, the Bank of England surprised markets by deciding not to raise its policy interest rate. Ahead of the decision, Bank of England Governor Andrew Bailey had said the central bank “will have to act” if inflationary pressures remain persistent, which investors and traders took to mean that a rate hike was imminent. Instead, the bank opted to hold its policy rate near zero. It said after the decision that, before raising rates, it needs a better picture of the British labour market after the end of the country’s pandemic furlough scheme in September.
The Bank of England’s decision to hold pat on rates caused a sharp repricing in global bond markets. Yields on two-year British government bonds fell 21 basis points that day (a basis point is one one-hundredth of a per cent), and other markets, including the Canadian bond market, experienced fluctuations.
The preceding two months had already seen significant turmoil in global bond markets, as investors rejigged their portfolios to account for changing central bank narratives around inflation and prepare for earlier and more rapid rate hikes.
“The market had believed that central banks would move very slowly. As central banks have begun to move faster in their communication, the market has tried to in turn move even faster than central banks,” said Ian Pollick, global head of fixed income at CIBC Capital Markets.
That has meant intense selling of short-dated securities, which has pushed up short-term yields (bond prices and yields move in opposite directions). Yields on two-year Canadian government bonds, for instance, doubled in October.
“It’s always a balancing act between who’s moving first. ... If the forward parameters have changed, then the market has to move even faster to get ahead of it, and therefore it opens itself up to this extreme bond volatility that we’ve seen over the past couple of months, and in particular over the past week,” Mr. Pollick said.
Yields on short-term securities have retreated in recent days after the Bank of England’s surprise on Thursday, but remain elevated compared with a month ago. This is especially true for Canada, where Mr. Macklem’s hawkish shift has been less ambiguous than at the Fed or Bank of England. Markets are pricing in at least four interest rate hikes next year in Canada, compared with only two in the United States.
Derek Holt, head of capital markets economics at the Bank of Nova Scotia, said the market may have been overly aggressive in pricing in Bank of Canada interest rate hikes as early as January, which is three months ahead of the earliest date Mr. Macklem has hinted at. But he said the overall path for interest rate hikes being priced in for next year is “quite reasonable.”
“There’s less of a burden in making these decisions when you are a modest regional central bank, than when you’re [a] central bank to the world like the Fed,” Mr. Holt said, pointing to the importance of the U.S. central bank in the global financial system.
“The [Bank of Canada] has worn it with a bit of a badge of honour that they have already moved well ahead of the Fed on all of its policy measures.” Canada, he pointed out, began tapering its quantitative easing program a year ago. This, he said, makes it likely the Bank of Canada will be more aggressive on rate hikes than the Fed.
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