Bank of Canada’s Tiff Macklem urges calm, says price spikes still look transitory

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Bank of Canada governor Tiff Macklem left the door open for further tapering of the central bank’s bond-buying program, using his first public appearance in a month to say he remains confident that economic growth will be “strong” over the second half of 2021.

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His assertion was significant because forecasters and investors have turned glum in recent weeks. The Conference Board of Canada this week said gross domestic product (GDP) will expand 5.1 per cent this year, compared with a previous estimate of 6.7 per cent, citing weaker exports.

The business press is replete with stories about stagflation, as price indexes surge to their highest levels in decades despite flagging growth. Canada’s consumer price index (CPI) increased 4.1 per cent in August from a year earlier, well outside the Bank of Canada’s comfort zone of one per cent to three per cent.

It’s all made the markets for bonds and stocks jittery. Some investors wonder if traders are now conditioned to expect central bankers to keep interest rates pinned at zero, oblivious to the possibility that policy-makers could blink in the face of rising prices and begin lifting borrowing costs in order to satisfy their inflation targets.

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The Conference Board’s new outlook sees the CPI running ahead of the Bank of Canada’s two-per-cent target for another year, suggesting Macklem and his deputies will face constant pressure to reduce monetary stimulus.

“It’s a completely artificial market and it’s priced as if it’s priced for deflation, not for inflation,” Jim Keohane, the former head of the Healthcare of Ontario Pension Plan, told the Financial Post recently. “The bond market is pricing as if inflation is going to be transitory, and maybe it will be, but if it’s not, I think there’s a lot of downside risk.”

Macklem used what were likely his final public remarks before the Bank of Canada’s next interest-rate announcement on Oct. 27 to urge calm, emphasizing that nothing much has changed over the past few weeks. He also still thinks inflation is transitory, arguing that most of the upward pricing pressure is coming from “unique circumstances” related to the pandemic.

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Those circumstances could persist longer than central bankers anticipated earlier this year, but they should recede in time, Macklem told reporters on Oct. 7. He cited the example of lumber prices, which skyrocketed when there was an extreme mismatch between demand and supply, but crashed as soon as sawmills caught up to their order books.

“There is a lot of ingenuity. We do tend to work through these” price spikes, he said. “It’s going to take some time.”

More important were his comments on the growth outlook. The Bank of Canada in July predicted Canada’s GDP would expand six per cent in 2021, a forecast that now looks overly optimistic. The same forces that are pushing prices higher — extreme supply shortages and transportation bottlenecks — are also impeding growth by slowing factory production and exports.

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But Macklem is assuming unmet demand during the summer represents future demand once supply catches up. For example, he noted that companies have been adding to their vehicle fleets at an unusually slow pace, as the computer-chip shortage has forced automakers to curb production. But those fleets still need to be replenished, and companies will do so as soon as vehicles are ready.

In the meantime, the governor noted that household spending remains strong, and that should be enough to carry the economy for at least a few months. Statistics Canada last week reported that economic growth was stronger in July than initially expected, and that the economy probably grew 0.7 per cent in August, much more than it typically grows from month to month.

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“The track for GDP growth is probably a little bit slower than what we put out in July, but we do continue to expect a good rebound,” Macklem said.

Macklem declined to answer a direct question on whether the central bank will further reduce its purchases of government debt, an aggressive form of monetary policy it initiated to fight the COVID-19 recession. Most on Bay Street assume it will, if only as insurance against the possibility that inflation is stronger than policy-makers assume.

If Macklem is right that the recovery remains on track, there would presumably be little reason to carry on with an emergency measure if the danger has passed.

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