In his first public address of 2023, Bank of Canada (BoC) Governor Tiff Macklem asserted that inflation cannot return to the 2% target in 2024 if wage growth remains within the current range from 4% to 5%.
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“If it stays in this zone when inflation falls, it will make it difficult to bring the inflation target back to 2%, unless there is a strong increase in productivity; stronger than what we have seen in history,” said Mr. Macklem in the press conference following his speech in Quebec.
The risk of such a scenario now appears to be diminished according to Mr. Macklem, as a survey of companies shows inflation expectations falling slightly. However, this risk must be considered in a labor market that is still overheated and at a time when workers are trying to maintain their purchasing power. But the BoC will not ask employers to help it in its fight against inflation.
“It’s not the Governor of the Bank of Canada’s job to tell contractors how much to pay their employees and it’s not our job to tell employees what they should charge for wages,” Macklem said. .
Zero economic growth
The BoC is expecting almost zero economic growth for the next three quarters in Canada, which should ease inflationary pressures a little. Prices have started to decline on the goods side, but this is not yet the case on the services side, largely due to high labor costs in a particularly tight job market.
The BoC nevertheless expects a slight increase in the unemployment rate, which should help reduce wage growth.
Risks around forecasts
“There are risks around our projection. The most important thing is that world energy prices rise, which would drive up inflation. We also fear that inflation expectations will remain high and that increases in labor costs will persist,” explained Mr. Macklem to business people in Quebec City.
Downside risks also exist. If Canadian households limit their spending more than expected to adjust to the rise in interest rates, the effect on the economy could be brutal.
“But with inflation at over 6%, still well above our target, we remain more concerned about the upside risks,” explained the governor.
Should the upside risks materialize, the BoC would not hesitate to raise its key rate further to bring inflation back to the 2% target in 2024. The key rate has increased by 4.25 points since March 2022, which pushed up interest rates and caused a contraction in the real estate market.
