OTTAWA--A new quarterly forecast for inflation set for release next month will tip the balance on whether the Bank of Canada needs to raise rates to contain price increases, Gov. Tiff Macklem said.
In remarks on Monday in a speech and a press conference, he said upside inflation risks have intensified with the war in the Middle East showing no signs of ending. Crude oil has traded near $100 a barrel in the past week, and inflation in Canada is set to edge upward from its current 3% level should fuel costs remain in elevated territory, Macklem said.
The next Bank of Canada decision is set for Oct. 28, at which time it will also present an updated growth and inflation forecast to Canadian.
"The key question we're going to be asking ourselves is, 'Is the current interest rate the right one to bring inflation back to the 2% target over time, or do we need to raise the interest rate to guide inflation back to our 2% target?'" he said at the press conference.
Canada's central bank sets interest rates with an eye toward achieving and maintaining 2% inflation, or the midpoint of a 1% to 3% range. Total, or headline, inflation in Canada has been at or above 3% in three of the last four months, although readings that strip out volatile items like food and energy indicate price increases are closer to 2%.
Macklem's speech in Halifax, Nova Scotia, spelled out how the central bank is grappling with higher energy prices stemming from the Middle East conflict and the return of heightened trade uncertainty.
Central bank officials are prepared to adjust policy depending on these two dominant risks evolve, Macklem said, adding policymakers will closely monitor how firms and households respond.
"We don't want to raise our policy rate and restrain growth if inflationary pressures are contained. But nor do we want to be too slow to respond if inflationary pressures are becoming more persistent," Macklem said.
Generally, the central bank estimates that a 10% rise in crude-oil prices would add about 0.20 percentage points to headline inflation. Macklem said this time around, the damage to refining capacity has sparked a faster increase in fuel costs relative to benchmark oil prices. he added that current gasoline prices in Canada are more consistent with a barrel of crude trading at $140, instead of $100.
Royce Mendes, head of macro strategy at Desjardins Group, said the central bank appears to be setting the stage for an October rate increase should energy prices fail to retreat from current levels, "but that's far from a foregone conclusion."
Countering the risk of upside inflation is the the escalation in the U.S.-Canada trade conflict. The imposition of new hefty tariffs by both countries is likely to weigh once again on investment and hiring decisions. "If growth weakens once again for several quarters, economic slack will persist, making it harder for businesses to raise prices," he said.
Macklem added that fourth-quarter growth could slow sharply to below 1% annualized should U.S and Canadian tariffs remain in place. In July, the central bank projected third quarter growth of 1.5% -- after strong second-growth expansion of 3.3% that blew past initial Bank of Canada's expectations.
The yield on the two-year Canadian government bond has recently traded more than one percentage point higher than the Bank of Canada's policy rate of 2.25%, which indicates that fixed-income traders expect rate increases in the near future. The Bank of Canada kept its policy rate unchanged this month at 2.25%, although Macklem at a press conference adopted a more alarmed tone regarding inflation as the U.S.-Iran war shows no signs of ending. That conflict, which started in late February, has effectively shut down oil shipping through the Strait of Hormuz and damaged refinery capacity.
"We are going to make our best judgment and decide what we think is the best thing to do to bring inflation back to target," said Macklem, when asked about traders' expectations.
A good portion of Macklem's speech documented how Canadian businesses have adapted to the changing trade environment, as well as the adoption of artificial intelligence and aging demographics.
Second-quarter data showed a strong 14.5% climb in nonenergy exports, reflecting what Macklem said were business decisions to reduce their tariff exposure and adjust their supply chains. "Canadian businesses are building resilience by broadening their options," the governor said, adding that puts the economy on stronger footing amid a fresh bout of cross-border trade uncertainty.
Comments