MNI: World Heading Towards Faster Inflation Era, BOC Says

The global economy may be entering a new era of stronger price pressures with governments pulling back on free trade and companies seeking shorter supply chains, Bank of Canada Governor Tiff Macklem said Monday, which could make it harder for the central bank to meet inflation targets.

Inflation and interest rates have been held down for several decades by production gains linked to free trade such as expanded production from China and Eastern Europe, Macklem said in a speech in Vancouver. Russia's invasion of Ukraine and its "weaponization of its natural gas supply" will likely mean companies and governments seek shorter and more trusted supply chains, boosting costs, he said. 

"Over the long term, it seems likely that we won’t have the same disinflationary forces that we’ve had for the past 30 years. These potential developments could make it harder to bring inflation back to the 2% target and keep it there," Macklem said. "But how much harder is very difficult to say."

The Bank has been largely successful over the last two decades meeting its 2% inflation target but was surprised last year by the sluggish recovery of supply chains, the jump in commodity prices after the Ukraine invasion and how the pandemic put intense pressure on goods and services prices. Macklem's speech reiterated last week's decision to hike the key lending rate 50bps to 4.25% and the pivot to say policy makers are now looking more at data to decide if it's necessary to keep tightening. 

Comments about a new inflation era are some of Macklem's most detailed to date, and join a wider discussion about whether some of the inflation run-up will persist beyond the shocks of Covid and the Ukraine war. 

One example of changing pressures is that for the last three decades supply shocks like in energy tended to have a temporary effect on inflation that central banks could look through, Macklem said, and things are now turning out differently. "The lesson from 2022 is that even if long-term inflation expectations are well anchored, when the economy is in excess demand, businesses raise their prices more quickly and by more when their costs increase," he said.

The Governor also said he's mindful that in Canada, upside inflation risks are more dangerous because price gains could become embedded. 

"We are trying to balance the risks of over- and under-tightening monetary policy," Macklem said. "If high inflation sticks, much higher interest rates will be required to restore price stability, and the economy will have to slow even more sharply."

"Looking ahead, we will be considering whether there is a need to increase the policy rate further. This means that decisions to raise the rate or to pause and assess the impact of past rate increases will depend on incoming data and our judgments about the outlook for inflation," he said.