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The possibility of a second wave of price pressures raises some difficult questions for economists and policy-makers as we approach a key juncture in the inflation fight, David Parkinson writes.Mark Blinch/Reuters

Perhaps the most disconcerting thing about the inflation surge of 2021 is that the biggest inflationary threat hasn’t even kicked in. Yet.

Maybe it never really will. Still, the possibility of a second wave of price pressures – these brought on by fast-rising wages – raises some difficult questions for economists and policy-makers as we approach a key juncture in the inflation fight.

This is what Royal Bank of Canada chief executive officer Dave McKay was talking about last week, when he publicly warned the Bank of Canada in a Bloomberg News interview that it needed to take “rapid action” to launch “a series of rate increases” to squelch this inflation problem. He believes the buildup of inflation since last spring has let the wage-growth genie out of its bottle, and even if current temporary pressures ease, no one’s putting it back in – workers will still demand pay increases to compensate for the rise in consumer costs, and those increases are never going to be reversed.

The danger is that the economy gets caught in a wage-price spiral – the dreaded state in which higher wages fuel higher prices, which trigger still higher wage demands, in a vicious circle.

“We’ve never really gone back as a society and reduced wages because inflation was temporary,” Mr. McKay told Bloomberg. “This is permanent, sustained inflation that has to be dealt with through monetary policy, and therefore we need rapid action this spring as a series of rate increases to address it.”

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When the head of the country’s biggest private-sector bank publicly warns the Bank of Canada that it needs to get on its interest-rate horse, quickly, to fight a serious inflation problem, it certainly attracts attention – not least for the timing of the pointed comments. This Wednesday, Statistics Canada releases its December consumer price index report, which looks likely to show that inflation inched up slightly from the 18-year high of 4.7 per cent in November. A week later, the Bank of Canada will announce its decision on interest rates – with pressure building on Governor Tiff Macklem to signal that interest-rate hikes are imminent to stem the inflation tide, if not actually let loose with his first rate hike.

Mr. McKay declined an interview with The Globe and Mail to elaborate on his Bloomberg comments. But for what it’s worth, RBC’s own economists aren’t nearly as worried as their CEO. They forecast that the inflation rate will slow to about 2.4 per cent by the fourth quarter of 2022, and below 2 per cent by the second half of 2023. They don’t expect the Bank of Canada to begin raising rates until the central bank’s April 13 decision – which would mean holding steady both next week and in the bank’s March 2 rate announcement.

In an interview Friday, RBC chief economist Craig Wright didn’t sound entirely sold on his boss’s case.

“To the extent that [elevated inflation] stays around too long and gets worked into expectations, then you will see a more persistent pressure from the wage component. We just haven’t seen that yet,” Mr. Wright said.

“To date, the wage numbers have been surprisingly soft.”

December’s year-over-year wage growth was 2.7 per cent – a pretty normal pace by prepandemic standards. Still, the pace of wage growth has accelerated over the past few months. There may be more to come.

In a recent interview, former Bank of Canada governor Stephen Poloz noted that the start of a new year is when a lot of wage decisions get made between workers and their employers, and the previous year’s inflation rate will serve as a benchmark. With that benchmark ending 2021 at something approaching 5 per cent, it’s easy to imagine upward pressure in those wage negotiations.

But Mr. Poloz isn’t convinced that businesses will necessarily pass higher wage settlements through to their customers. He cites strong corporate profits as a key mitigating factor: The companies that make up the S&P/TSX Composite Index recorded their largest collective profit increase in history last year.

“A lot of firms might be able to just say, ‘No, to stay competitive, I’m not going to try to pass this through,’” he said. “As long as that’s true for a majority of the economy, you don’t get the start of a spiral.”

There may be another reason why employers won’t feel pressure to pass along wage increases to their customers.

Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, noted in a report last week that hiring in Canada has far outstripped output growth in the past year. (Quite possibly, businesses have been hiring in anticipation of further fading of the pandemic, as well as to secure workers in the face of labour shortages.)

As a result, unit labour costs – essentially, the worker costs that go into each good or service that businesses produce – have surged, adding to inflation pressures. On the other hand, all that labour is already in place to increase output in the coming year without adding more staff. On a per-unit basis, labour cost growth could actually slow.

“That, too, will help ease inflation pressures somewhat,” he said.

Monday morning’s quarterly Business Outlook Survey from the Bank of Canada could provide an important window into where businesses are leaning – or, at least, where they were leaning before the Omicron variant arrived in earnest, as the survey predates this big surge of cases. If businesses sound a clear warning that they are about to sharply increase wages and pass those costs along to consumer prices, then the Bank of Canada will have to pay considerable heed to Mr. McKay’s warning.

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