On June 1, the Bank of Canada announced that it would raise its policy interest rate by half a percentage point. On June 2, Deputy Governor Paul Beaudry discusses why inflation has been higher than expected and what steps the bank is taking to return to its two percent target. The Bank of Canada’s target for the overnight rate was increased by half a percentage point on June 1 to 1.5%. Quantitative tightening measures are also continuing.
Economic update since April
Though the Canadian economy has recovered rapidly from COVID-19, there are still some negative effects being felt. Inflation is high, which impacts families and businesses alike. This is especially difficult for those on fixed incomes or low salaries. We expect these trends to continue in the coming months.
Preventing high rates from becoming entrenched
Our team’s primary focus is to lower it again so that buying necessities isn’t as expensive for Canadians and to stop higher rates from becoming permanent.
Self-perpetuating inflation happens when prices start to increase and then continue to do so because other companies’ prices are also going up, as well as the cost of labor. In a situation like this, people begin to expect that inflation will stay high or keep getting worse, which in turn reinforces the initial problem.
Although the rate in Canada is too high, it isn’t at a point where it’s self-fulfilling or entrenched. There are external forces causing this inflation, like Russia’s invasion of Ukraine and continuous supply disruptions.
Even so, the Bank is working to bring inflation back down and prevent it from becoming entrenched. When high inflation becomes entrenched, it’s hard to get it back down without causing damage to the economy.
Domestic versus international drivers
The current high rate is being driven by two distinct sets of forces—one domestic and the other international.
Inflation has lately been driven upward by excessive demand in the Canadian economy. When economies experience excess demand, central banks increase interest rates to address it. The Bank of Canada began raising rates in March when we saw that the Canadian economy was once again at maximum capacity. However, international circumstances have pushed inflation to new heights in recent months.
The world still hasn’t fully recovered from the pandemic, and this has led to shortages in industries such as energy, electronics, etc. The war in Ukraine made matters even worse by skyrocketing prices.
Domestic economies are unable to regulate the prices of imported goods. Inflationary upsets from abroad are usually transitory. As a result, central banks do not typically raise interest rates in response to this inflation.
Balancing trade-offs
Trade-offs are a fact of life when it comes to monetary policy. Last year, we decided not to raise rates not only because overseas inflationary shocks seldom last long, but also because we wanted to make sure that those who lost their jobs during the pandemic could get back to work.
The current situation is not the same as it was in the past. The initial impacts on global supply chains have lingered longer than initially thought, due in part to the war in Ukraine and renewed lockdowns inside China. If inflationary expectations rise, there is a greater chance now that high inflation could take root. To avoid this potential outcome, interest rates need to be increased.
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To learn more, please feel free to contact our team of experts!
