Inflation should fall quickly in the coming months, but getting it back to 2 per cent could be a long slog, Bank of Canada Governor Tiff Macklem said Thursday, suggesting that interest rates may need to remain elevated for some time.
Speaking in Washington a day after the Bank of Canada’s latest rate decision, Mr. Macklem said he expects the annual rate of consumer price index inflation to fall to 3 per cent by the summer, down from 5.2 per cent in February.
That’s the easy part. It could then take until the end of 2024 to get inflation all the way back to the bank’s 2-per-cent target, he said. And a number of things need to fall into place for this to happen, including a slowdown in service-sector inflation, a moderation of wage growth and a return to normal corporate price-setting behaviour.
Given the challenges of getting back to 2 per cent, some commentators have argued that central bankers should learn to live with slightly higher inflation. Mr. Macklem suggested that this isn’t an option.
“We have a [inflation target] band of 1 to 3 per cent, but what I would stress is that band is not a zone of indifference,” he said in a conversation hosted by the International Monetary Fund.
“You need to aim for the middle of the band if you want to be in the band most of the time. So we need to get inflation recentred on 2 per cent.”
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The Bank of Canada is no longer raising interest rates, at least for now, having paused its rate-hike campaign in March and kept its benchmark interest rate steady at 4.5 per cent on Wednesday. Central bank officials maintain that they could still raise rates if inflation proves more stubborn than expected.
Interest rate swap pricing, which captures market expectations about monetary policy, sees the central bank starting to cut interest rates in December. Mr. Macklem pushed back against this after the rate decision on Wednesday, saying that the prospect of rate cuts this year “doesn’t look today like the most likely scenario to us.”
This moderately hawkish stance is bolstered by recent data that show the Canadian economy has held up better than expected in early 2023, despite much higher borrowing costs. That’s been good for businesses and workers, but a challenge for the central bank, which is actively trying to cool the economy to bring down inflation.
The bank expects the Canadian economy to slow in the coming quarters as higher debt-servicing costs eat into consumer spending and business investment. It also expects exports to fall as the U.S. economy slows in response to tighter monetary policy and worsening credit conditions after the failure of several regional banks.
So far, Canada has been largely unaffected by the recent banking-sector turmoil in the United States and Europe, Mr. Macklem said Thursday.
“With generally credit conditions tightening, equity prices of banks down globally, you’re seeing a little bit of spillover into Canada. But honestly, it’s really been quite muted,” he said.
Nonetheless, strain in the financial system could have an effect upon the Canadian economy if U.S. banks pull back on business lending, leading to lower demand for Canadian exports. And central bankers and regulators need to remain vigilant about further cracks in the banking sector, Mr. Macklem said.
“If you go back to the global financial crisis, there has been considerable strengthening of the system since then: higher capital standards, higher liquidity standards, limits on leverage. That has certainly made the system more resilient, but we certainly don’t want to be complacent,” he said.
“The financial system, like the rest of the economy, has to adjust to higher interest rates. And we do need to be ready for the possibility that there could be some issues.”
Mark Rendell