Bank of Canada says lower economic growth is necessary to restrain inflation

According to Bank of Canada senior deputy governor Carolyn Rogers, the way back to 2% inflation will take some time and will require a period of lower economic growth.

Her speech follows the BoC’s key interest rate increase by 0.75% and a warning of more hikes coming in the nearest future.

Rogers says yesterday’s decision was based on the governing council’s concern about the risk of inflation becoming “entrenched.”

In July, the national annual inflation rate was 7.6%, going down from June’s 8.1% due to lower oil prices.

Nevertheless, she says the governing council’s worries come from the central bank’s core measures of inflation, which is less volatile. That indicator was up in July, pointing to “how strong underlying inflation remains” amid high inflation expectations.

As a rule, central banks start worrying when people and businesses expect high inflation as it can lead to a self-fulfilling prophecy. Businesses expecting high inflation will set prices higher while workers will demand wage rises to match up with their expectations of inflation.

“We want to make sure this scenario does not materialize as if it does the economic cost of restoring price stability will be much higher,” – Rogers explained.

She says global supply issues and elevated commodity prices combined with an overheated Canadian economy keep pushing prices up.

“As we are facing excess demand right now, we need a period of slower economic growth in order to balance conditions and bring demand back in line with supply,” – Rogers added.

She noted that the BoC will keep monitoring how the economy is reacting to higher interest rates as well as global economic developments, and will assess how much higher the rates need to go.

Higher inflation and interest rates should reduce consumer spending, but extra savings accumulated during the pandemic may ease the hit for household budgets, Rogers believes.

She warns that the Bank’s recent decision will show their full impact during the next 2 years.

Rogers ended her speech by reiterating the central bank’s promise to bring inflation down to its target level.

“We are determined to get this job done,” – she said.