MNI INTERVIEW: Big CPI Undershoot Unlikely- Ex-BOC Schembri

MNI (OTTAWA) - “The bigger risk is that inflation will be hard to keep close to 2% from above, rather than from below,” said Schembri, who served on the Bank's rate-setting panel from 2013 until June 2022.

Investors predict BOC Governor Tiff Macklem will cut a third time Wednesday after the last inflation report showed price gains slowing to a three-year low of 2.5%. The Bank has a single target of keeping inflation in the middle of a 1% to 3% band and officials have long said that target is symmetrical. Macklem said in July more rate cuts can be justified as inflation slows, and risks are titling away from elevated price gains of the last few years. 

"With the target in sight and more excess supply in the economy, the downside risks are taking on increased weight in our monetary policy deliberations. We need growth to pick up so inflation does not fall too much," Macklem said after the July 24 decision.

PRODUCTIVITY QUESTION

Schembri declined to comment on near-term monetary prospects. He said the Bank's job is made more complicated by policies to bring in record numbers of immigrants and more recently to curtail those flows amid signs of a weaker job market and housing shortages.

Estimating hours worked is fine but he said “it’s extremely difficult” to assess whether bringing in low-skilled workers further weighs down productivity. 

“You have to change the modelling because the labor force growth is coming from a different type of worker and so it’s more difficult to accurately get a sense of what the increase in potential output would be,” Schembri said. “It’s probably, other things being equal, slower than what we had in the past.”

“It’s going to add to some extent to the inflationary pressure in the economy, so that makes it difficult for the Bank,” he said.

WAGE FIGHTS

The Bank pointed to signs of labor slack as it cut rates and officials are monitoring wages still rising by around 5%. Workers are seeking to catch up with inflation that had surged to 8% and that's motivated recent disruptions at airlines, railways, ports and public-sector unions.

“Some industries can probably accommodate a wage increase commensurate with the increase in the overall price consumption basket, but other industries can’t because they’re more competitive,” Schembri said. “That’s where you would get these scrapes between management and labor." (See: MNI INTERVIEW: BOC Has Little Room For Aggressive Cuts- Spence)

Canada also faces uncertainty around U.S. elections with Donald Trump threatening tariffs despite a free trade agreement with its northern neighbor. Even with potential gains from "friend-shoring" as trade with Russia and China dwindles, Schembri sees inflation risk linked to trade. 

“The greater likelihood is that with de-globalization and friend-shoring, costs will be higher, you could see a lot of spending on certain things like metals given the levels of defense spending” and mitigating climate change, Schembri said. 

SMALL UNDERSHOOT OK

Pain felt by workers and consumers shows why keeping inflation low and stable is important, and past Bank surveys showed people prefer inflation closer to zero, he said. “They know it’s difficult for the average person to stay ahead,” Schembri said. “That’s why I’ve always been very much in favor of low inflation.”

Prospects of inflation sticking much below targets appear to be limited by the experience of the pandemic when medium-term inflation expectations stayed in line even as headline prices surged, Schembri said. That showed the value of inflation targets as economic stabilizers, he said, adding some global officials in the previous era found it's best not to obsess over small downside deviations.

“This time around central banks will get less exercised about it because the average person didn’t feel that was a huge problem,” he said. “Somewhere between 1.5 and 2 percent, I think the average person did not perceive that as a problem.” (See: MNI INTERVIEW: BOC Cuts Will Be More Hesitant- WLU Researcher)