People walk through Dufferin Mall in Toronto, on Oct. 27.Christopher Katsarov/The Globe and Mail
It might not feel this way in the heat of the moment, but we may look back on last week as the point when the Great Inflation Panic of 2021 turned a corner.
That seems an odd thing to say about a week when inflation fever seemed to rise to a whole new level. Judging by the discussions coming from central bankers, economists, market strategists, real estate agents, politicians, Twitter threads, Facebook friends, e-mailers, curling opponents, the guy who cuts my hair – it seems it’s about all anyone wants to talk about. The Bank of Canada’s policy announcement in the middle of last week – in which it said that it would likely start raising interest rates a few months earlier than previously expected – cranked up the general anxiety even more.
But amid the headache-inducing buzz, the week contained several signs that the boil is about to come off Canada’s inflation story. If runaway prices are your biggest worry, then this was actually a pretty encouraging week.
Soaring inflation, recovering job market raise pressure on Bank of Canada to hike interest rates
First, the Bank of Canada’s moves were an unmistakable policy volley aimed at inflation fears. The bank’s accelerated timetable on the start of rate hikes – while officially justified on the grounds that it now sees the economy reaching full capacity sooner than previously expected – sent a strong message to financial markets and the Canadian public that the bank is prepared to clamp down on inflation pressures.
The prospect of earlier-than-expected rate increases will also add fuel to the Canadian dollar. That, too, will put a chill on inflation pressures, as it serves to reduce costs of imports.
Meanwhile, the central bank also reduced its government bond-buying program – known as quantitative easing, or QE – to the point where it is no longer expanding, but merely keeping the bank’s bond holdings in a steady state. This is good news for those in the camp (head counsellor: Conservative MP Pierre Poilievre) that believes QE is igniting inflation by flooding the economy with new money supply. Effectively, the bank just shut off the proverbial money-printing press.
Those monetary policy actions were made at the same time we learned that the pace of the economic recovery has appreciably slowed.
The Bank of Canada trimmed its growth forecast for this year to 5.1 per cent from 6 per cent, pointing to a less torrid rebound in the second half of the year than it had previously anticipated.
Even that scaled-back forecast looked optimistic two days later. Statistics Canada’s gross domestic product report for August and its preliminary estimate for September suggested that growth managed only about a 2-per-cent annualized pace in the third quarter, far below the Bank of Canada’s estimate of 5.5 per cent.
Normally, this wouldn’t be something to cheer. But what’s notable is the key factor behind this growth slowdown: Severe strains in supply chains have, effectively, slammed the brakes on otherwise buoyant consumption.
From an inflation standpoint, that development could offer some much-needed relief. While the surging prices have routinely been blamed on global supply bottlenecks that emerged in the pandemic reopenings, it’s important to remember that a booming recovery on the demand side has placed extreme pressures on those struggling supply chains. Some modest cooling of demand – as it now appears we’re seeing – will ease some of that inflationary pressure as supply chains play catch-up.
All of this developed just days after the expiration of major federal government pandemic support programs for businesses and individuals, which are being replaced by much smaller and more targeted supports for the next six months. Those programs were a major source of fuel for the rapid rebound in demand this year; their withdrawal, in turn, should turn down the dial on the inflation equation.
For some, the sudden awareness that interest rate increases are on the (still quite distant) horizon has brought a new fear: that soaring borrowing costs will choke off the housing market, stifle economic expansion and place indebted households in peril. Here, a bit of perspective is required. With the Bank of Canada’s policy rate entering this process at a record-low 0.25 per cent, interest rates will still be in very affordable and economically stimulative territory long after the central bank begins to raise them. (The central bank’s estimate of the neutral rate – at which interest rates neither stimulates nor retrains economic activity – is about 2.25 per cent.)
Naturally, there is nervousness when we see economic growth slowing at the same time as inflation is rising. The term “stagflation” has started to creep into the economic conversation – a serious economic affliction marked by both stagnant growth and high inflation. But as fun as the word might be to kick about, let’s not confuse the current situation with stagflation. With growth at 5 per cent this year, we’re a very, very long way from the definition.
We need to remember that this recovery is still very young. We’re experiencing growing pains – and we’ll probably experience a lot more before we’re done. At least for the current inflation-fearing phase of this process, forces have begun to align to ease those pains.
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David Parkinson