Expected slow return to Canada’s inflation target defuses rate-cut bets
2022.08.18 15:45
FILE PHOTO: FILE PHOTO: A sign is pictured outside the Bank of Canada building in Ottawa, Ontario, Canada, May 23, 2017. REUTERS/Chris Wattie/File Photo
By Fergal Smith
TORONTO (Reuters) – Canadian inflation is not likely to return to the central bank’s 2% target until 2024 after possibly peaking in June, as less volatile items like wages and rent displace energy as key sources of price pressure, analysts say.
In a bid to return inflation to target, since March the Bank of Canada (BoC) has raised its benchmark interest rate by 225 basis points to 2.50%, including a full-percentage-point move in its last policy decision in July, the biggest single hike by a G7 country in this economic cycle.
A slow grind back to target could make the central bank less willing to pivot to interest rate cuts next year if the economy moves into recession as some analysts expect.
Earlier this month, expectations were building that the central bank would be cutting rates as soon as next March.
“Even with the economy likely to see a mild recession next year, we think it will take until 2024 to get inflation back to target, or reasonably close,” said Josh Nye, senior economist at Royal Bank of Canada.
The Bank of Canada’s latest forecast, in July, was for inflation to return to 2% by the end of 2024 and for the economy to avoid recession.
Canadian inflation slowed to 7.6% in July on lower gasoline prices, down from an almost 40-year high of 8.1% in June, but measures of core price pressures that strip out the most volatile components, such as energy, continued to climb.
The problem is that increases in slower-moving drivers of inflation like wages and rent are likely to be persistent, or sticky, even as commodity-price gains and some supply constraints caused by the COVID-19 pandemic and the Ukraine war ease, analysts say.
“The biggest theme from this latest (inflation) reading is a significant rotation in where the most intense price pressures are coming from,” Doug Porter, chief economist at BMO Capital Markets, said in a note.
“The Bank can scarcely back down anytime soon, as it has a long-term battle on its hands reining in 5% core inflation.”
Investors appear to have taken note, with money markets now expecting the central bank’s benchmark interest rate to peak at about 3.75% in the first quarter of next year and stay close to that level through much of 2023.
The Federal Reserve could also be facing a lengthy battle to bring inflation back to target. But it has a dual mandate of employment and price stability, unlike the single goal of low inflation pursued by Canada’s central bank.
“The BoC is most likely biased towards taking the risk of overtightening rather than undertightening until they see enough evidence that demand is cooling,” said Jimmy Jean, chief economist at Desjardins Group.
