—Deputy Governor: With Rates Higher, Inflation Lower, Policy Question Now is Whether More Rate Increases Needed
–Will Be Prepared to Act Forcefully on Upside Surprise but That’s Hypothetical
–High Inflation Largely from Global Factors but Strong Domestic Demand Becoming More Important
By Max Sato
(MaceNews) – The Bank of Canada has been making policy decisions by monitoring economic data closely, but the environment has shifted from the early state of the current tightening phase now that interest rates are much higher and inflation has eased slightly, Deputy Governor Sharon Kozicki said on Thursday.
She also told a news conference that she was talking in a “hypothetical” sense today when she mentioned in her speech the need to be “forceful” if economic conditions surprise to the upside.
In the Economic Progress Report she delivered at the Urban Development Institute of Québec in Montreal, Kozicki said, “If we are surprised on the upside, we are still prepared to be forceful. But we recognize that we have raised interest rates rapidly and that their effects are working their way through the economy.”
“In other words, we are moving from how much to raise interest rates to whether to raise interest rates,” she said.
Later, she told reporters that she used the term “forceful” because the bank’s policymakers do not want people to misinterpret the bank’s statement issued Wednesday that the “Governing Council will be considering whether the policy interest rate needs to rise further” after raising the policy rate by another 50 basis points to 4.25%.
“If there were to be a very large shock, we would be prepared to act forcefully to rein things in. That’s hypothetical. It’s the big if word,” she explained.
“We are looking at all the data and a revised projection in January,” she said, referring to updates on the bank’s medium-term growth and inflation forecasts in its quarterly Monetary Policy Outlook due on Jan. 25.
Asked how declining bond yields will affect the bank’s policy decision at its next meeting on Jan. 25, Kozicki said, “In general, we don’t look at day-to-day fluctuations in bold yields.”
“Financial conditions are an input, if you will, into our macroeconomic, and they will matter for evolution, but they are only one piece of information in terms of what’s happening,” she said. “Bond yields on the long horizon are often representative of all sorts of levels of interest rates that consumers and firms are facing when they look into borrowing funds. So, it does matter where those interest rates are, but we are looking at them in a much broader context.”
Canada is in an environment where interest rates are much higher, consumer inflation has eased slightly mainly due to lower energy prices, and some sectors of the economy is slowing amid rising borrowing costs, Kozicki said.
The bank is still monitoring the same data and surveys as before, but the starting point in the process of making policy decisions is very different now that the bank’s policymakers are “starting to see signs” that their past tightening is having effects.
“Earlier it was obvious what direction we needed to go in,” she said. “Our decisions are always data-dependent but the direction was already obvious. That’s why we have changed the way we are using the language.”
In her speech, Kozicki said, “Alongside yesterday’s decision, we indicated that that going forward, we will be considering whether to increase rates further. By that, we mean that we expect our decisions will be more data-dependent.”
Canada’s high inflation is coming largely from global factors, pushed up by energy and commodities prices and geopolitical risks, but domestic factors in light of strong reopening demand “have become more important this year” and that is part of the reason the bank tightened “aggressively earlier this year,” Kozicki said, in response to the question as to what portion of inflation is from global factors.
Labor shortages are “very generalized,” Kozicki said. The labor market is part of a broader economy, which is in excess demand and that’s why firms are finding it hard to find workers, she explained.
“We are likely to need to see unemployment rise somewhat in order to achieve our inflation target,” she said but didn’t say how high the jobless rate should rise from the latest level of 5.1% in November, down from 5.2% in October.
The year-on-year rise in the total CPI in Canada was steady at 6.9% in October, easing from the recent peak of 8.1% in June, but it is still well above the bank’s 2% target. Measures of core inflation remain around 5%. Three-month rates of change in core inflation have come down, an early indicator that price pressures may be losing momentum.
In her speech, Kozicki said food price inflation — especially compared with inflation of other goods — has continued to increase despite most agricultural commodity prices being well below their pandemic highs.
Asked about this point, Kozicki said profit margins have not changed much in the food-producing sector while high costs have been passed along rapidly.
“As we go forward now, we’ve already started to see declines in some of those costs, and we will be watching closely to see what happens to some of the other prices,” she said.
Generally, as demand eases off, businesses tend to be become more cautious about passing higher costs onto consumers, she said, adding, “We will be watching for more competitiveness pressures as being something that helps keep prices from rising more rapidly.”