Bank of Canada faces more challenges with assessing labour market conditions

According to the central bank’s deputy Governor Lawrence Schembri, the bank’s ability to determine when Canada’s economy has reached full employment, and when it’s time to raise interest rates, has become extremely unclear.

He says policy makers are truing to bring the national economy to full capacity with a maximum employment possible. However, assessing that level has become more difficult because of structural changes and the volatile influence of the pandemic on the labor market.

“It became more difficult to gauge labor market conditions, underlying capacity and inflationary pressures,” – Schembri noted. “As a result, we can see more uncertainty concerning the timing of when inflation may get back to the target level of 2%.”

Such comments are another reminder for the markets that the path to normalization is still basically uncertain and depends on the economic trajectory and health of Canada’s labor market. Governor Tiff Macklem pointed to the same issues on Monday, saying that although the timing of the next possible rate hike is “getting closer”, it will still depend on economic performance.

These statements show that the Bank of Canada wants to re-emphasize critical elements of its today’s guidance: no rate hikes until a full recovery is reached. During the previous rate meeting, the BoC shifted the timing of when it may possibly happen to April-September. Meanwhile, the Bank had earlier aimed at not sooner than July.

The central bank’s tome was more active than expected, surprising certain market players. Investors reacted by increasing bets on a more aggressive rate increase path. Now, markets expect the BoC to raise its key lending rate from today’s 0.25% to 1.5% during the next 12 months.

Schembri warns that the BoC may change its forecasts, based on the economic results.

He says there are signs that Canada’s labor market has shown a good rebound, “but there’s still excess capacity,” and that rates of unemployment and underemployment remain too high in case of certain groups. According to him, the Bank still believes the latest inflation hike is only transitory.

On Wednesday, we’ll see a report on October inflation. Economists expect the annual inflation to reach 4.7%, marking the largest number in 30 years.

Schembri says the BoC has been reviewing a wide range of labor market indicators in order to assess the recovery progress, including dividing conditions by age, gender and education. The research shows improvements in labor market conditions, although there are still some weak zones.