Stephen Poloz predicts inflation will slow quickly over the next 12 months

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Former Bank of Canada governor Stephen Poloz predicted year-over-year increases in the consumer price index will slow to a rate below three per cent of the next 12 months, an outlook that would allow current policy-makers at the central bank to take a gentler path back to a higher interest-rate setting.

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The consumer price index surged 5.1 per cent in January from a year earlier, well off the Bank of Canada’s target of two per cent, stoking concerns that the current governor, Tiff Macklem, has lost his grip on inflation. The Bank of Canada’s January forecast had the consumer price index averaging increases of 5.1 per cent over the first quarter, not jumping to that mark out of the gate.

Prices for financial assets tied to short-term interest rates imply investors are bracing for five or six quarter-point increases this year, starting on March 2, when Macklem and his deputies wrap their latest round of policy deliberations. The governor has all but confirmed that he will raise the benchmark rate from 0.25 per cent, but he has cautioned investors against assuming the rate is an escalator back to its pre-pandemic setting of 1.75 per cent. Not all of them buy it, and some wonder if the January inflation numbers will spook policy-makers into making a rare half-point change.

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Poloz, who was governor from June 2013 to June 2020, oversaw the deployment of unprecedented monetary stimulus to keep the COVID-19 recession from becoming something worse. Rather than inflation, he was worried about a corrosive deflationary spiral, a concern that was validated when the consumer price index turned negative in April and May of 2020.

We could have avoided these inflation pressures by having a depression. That wouldn’t have been the right choice

Stephen Poloz

Because of the way inflation is most commonly measured, that disinflationary period in the middle of 2020 exaggerated the severity of cost pressures as the economy turned around. The practice of benchmarking against the year-earlier month meant comparisons in 2021 were being made against an unusually low base. Now, the reverse is about to happen, as statisticians start comparing current prices against the elevated levels of last year.

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“Inflation is being overstated now because of the way it’s measured, Poloz said this week on the latest episode of the Financial Post’s Down to Business podcast. “Prices fell before they went back up and that’s not really being taken into account. Inflation will decelerate quite a lot this year for that reason alone. In addition, all the evidence is starting to come in that companies are dealing with their supply-chain issues.”

Poloz added: “I’m not saying it’s not an issue because it still has the potential to become a serious issue. The prospects are we’ll get a return back to around two per cent, or below three per cent, kind of range in the next 12 months. That’s all a pretty good story since we could have had the second Great Depression.”

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The former governor’s comments came before Russian President Vladimir Putin ordered an invasion of Ukraine, a provocation that caused global oil prices to spike above US$100 per barrel. British Prime Minister Boris Johnson said Western allies would respond with “massive” sanctions, heralding a renewed period of uncertainty of the sort that has disrupted supply throughout the pandemic.

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A war on Europe’s eastern fringe could temper central banks’ plans to raise interest rates, although it would take a lot for the Bank of Canada to delay setting off on a path to higher borrowing costs at this stage. The economy has fully recovered from the COVID recession, yet the policy rate remains at an emergency setting.

Poloz had a knack for distilling everything that was going on in the economy into a linear narrative when he was governor. By predicting inflation will drop relatively quickly, he is sticking to his own story about how cost pressures would evolve as the economy recovered from the pandemic. When the consumer price index pushed past three per cent in 2021, he advised households and investors not to worry, as it was a natural response to a mismatch between demand and supply. He observed in the interview that the most recent quarterly results of companies such as Walmart Inc. and Canadian Tire Corp. Ltd. suggest that companies are adapting to the post-pandemic environment.

Canadian Tire on Feb. 17 reported net income of $1.3 billion in 2021, a 41 per cent increase from 2019.

“The most important thing, in my view, is that we averted what could have been the second Great Depression,” Poloz said. “That’s a pretty big success. We could have avoided these inflation pressures by having a depression. That wouldn’t have been the right choice.”

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