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Alarming inflation in Canada signals aggressive interest rate hikes

Central banks must now show that the system they created works, and that the era of three decades of low inflation was no fluke.

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The only positive thing to say about the latest inflation numbers is that they could represent the peak.

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Statistics Canada’s consumer price index, which aggregates hundreds of goods and services to approximate spending patterns across the country, jumped 6.7% in March from a year earlier, the strongest increase since January 1991 and therefore the largest increase since the Bank of Canada began targeting inflation.

This is an alarming figure. The median estimate from Bay Street forecasters was 6.1%. The Bank of Canada, in a new forecast last week, said the consumer price index would rise an average of 5.6% year-over-year in the first quarter; the March number averages 5.8%. Inflation will need to slow significantly from its current rate to reach the central bank’s forecast of 5.8% in the second quarter.

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Alarming inflation in Canada signals aggressive interest rate hikes

Mathematics will make things better starting next month. Year-over-year increases in the consumer price index first exceeded the top of the Bank of Canada’s comfort zone of 1% to 3% in April 2021. Policymakers were relatively carefree, as the increase had a lot to do with how inflation is measured. The index had crashed in the spring of 2020 when deflation from the COVID-19 recession was the greatest threat, so increases 12 months later were exaggerated by “base effects”.

These base effects should start working in the opposite direction from next month. This could help Bank of Canada Governor Tiff Macklem ease fears of runaway inflation, as the sight of a falling headline figure could have a psychological effect on price expectations.

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However, there is little reason to assume that this will suffice. The increase in the consumer price index in 1991 was exaggerated by the introduction of the GST. Without this idiosyncratic event, the March increase would have been the largest since early 1983, the Western world’s last big fight with extreme cost pressures. The widespread adoption of inflation targeting in the 1990s was inspired by memories of that era. Macklem and his counterparts in the United States and elsewhere must now show that the system created by central bankers works, and that the era of low inflation that has existed for three decades was no fluke.

“We believe the (Bank of Canada) will continue to aggressively raise its key rate in the second half of the year,” said Charles St-Arnaud, chief economist at Alberta Central and a former Bank staffer. of Canada, in a note to customers. . “We wouldn’t be surprised to see another hike (by half a point) at the July meeting if inflation remains high in the coming months.”

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Macklem and his aides on the Board of Governors hiked the benchmark rate by half a point last week, an aggressive move meant to send a message that they are serious about controlling inflation. The change put the policy rate at 1%, and Macklem said he was ready to go above 3% if that’s what it takes to bring back annual increases in the consumer price index to the target of about 2%.

It might be difficult to keep expectations anchored at 2%. Almost everything was more expensive last month than in March 2021, with the notable exceptions of mortgage and telephone costs.

Alarming inflation in Canada signals aggressive interest rate hikes

Gasoline was the main driver, accounting for nearly 40% of the year-over-year increase, according to Statistics Canada. Housing costs were the other important factor. Yet excluding gasoline, the consumer price index rose 5.5% from March 2021, the most since the agency introduced its aggregate in 1999. The figure was 4.7% in February , suggesting that inflationary pressures have spread and intensified over the past month.

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Globalization has helped central bankers contain inflationary pressures for much of the past few decades. Freer trade and finely tuned supply lines stretching between the lowest cost producers and the greediest buyers have helped generate impressive growth rates with remarkably low inflation. This prompted central banks in advanced economies to keep interest rates low, encouraging a credit boom that eventually led to the Great Recession. This episode raised important questions about financial stability, but inflationary pressures remained tame.

Now these global interdependencies are the cause of much of the pain. The offer is exceptionally limited. The pandemic has upended production and transportation, and bottlenecks are still being resolved. Last year, drought and other extreme weather events hurt yields in some of the world’s major agricultural regions, including the Prairies. The war in Ukraine has aggravated a bad situation.

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At the same time, demand is stronger than few imagined it could be so soon after an epic recession. Unprecedented emergency benefits have left households with plenty of cash to spend in the aftermath of the recession, and unemployment in Canada is at an all-time high. The pandemic stimulus has all but disappeared, but the economy is still strong enough to withstand higher borrowing costs.

“Central banks need to take it down a notch,” said Tom O’Gorman, director of fixed income at Franklin Templeton Canada.

That’s what Macklem is trying to do. He fought a narrative that the Bank of Canada is behind the inflation curve. His critics are unaware that he intended to heat up the economy to help accelerate recovery from the COVID-19 recession. This strategy worked, but it did not anticipate serious supply disruptions and war in Europe. The central bank will have to continue to be aggressive in the coming months. He has few choices.

• Email: | Twitter: carmichaelkevin



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