Macklem plays down wage-and-spending surge but promises faster hikes if inflation spikes

Yesterday’s decision by the Bank of Canada to stop stimulating the economy with bond buying is already having a small effect on lending rates, said people who watch the mortgage market. 

But perhaps even more important is the fact that the Governor of the Bank of Canada Tiff Macklem has dramatically changed his message from one of relative complacency — that inflation would look after itself — to one where the central bank has committed itself to actively drive inflation down with cuts to stimulus.

Threading a careful path

The strategy is a tricky one, because Macklem wants to thread a careful path between scaring business investors and home buyers — with threats of high interest rates that could discourage new investment — while taking a hard enough line to convince everyone that the central bank will not let inflation persist in the economy.

Many bank economists, including Scotiabank’s Derek Holt and the Bank of Montreal’s Doug Porter seem skeptical that Macklem can have it both ways, suggesting that consumer spending and wage demands may push inflation, and the interest rate hikes needed to fight it, up faster than the Bank of Canada is willing to project in its latest Monetary Policy Report (MPR). 

Both economists remarked on Macklem’s sudden change in tone. As well as abruptly ending the stimulating effect of quantitative easing — the purchase of bonds in the market to make borrowing even cheaper and easier for those who could afford to borrow — the central bank has announced it will begin raising interest rates in the middle of next year.

The Bank of Canada expects consumer spending to be the major economic driver as the economy reopens. Its governor expects supply problems will help push prices higher, contributing to inflation.

But while the Macklem expects people with pandemic savings will only spend 20 per cent of that cash on goods, others, including the boss of RBC, David McKay, have predicted consumers will go on a major spending spree , driving inflation to new heights. It’s possible that rising inflation would actually encourage spending as people watch the value of their savings shrink.

In any case, retail bank economists seem to widely agree that both inflation and rates rises will be sooner, more frequent and ultimately higher.

Earlier, faster and higher

Clearly, the risks are tilted to an even earlier move, and — yes — the possibility of a faster cadence, and a higher end point, wrote BMO’s Porter in a release shortly after the central bank put out its October MPR.

Although he said they would not likely be needed, Macklem conceded the bank could move faster on rates. In response to a direct question about whether the central bank would continue to push rates higher if inflation persisted, Macklem gave a tough, if slightly confusing confirmation in central-bank-speak.

What did you expect?

What Macklem seemed worried about were inflationary expectations, the idea that if we are all certain that inflation is on the way up, workers will demand higher wages and businesses will raise their prices, effectively making inflation rise. Some say that process has already begun as global supply bottlenecks push prices higher and labour shortages increase wage demands.

Certainly Macklem seemed to play down the effect of wage demands, saying there were few signs yet of pay increases contributing to inflation. But as Scotiabank’s Holt noted, with the Bank of Canada projecting inflation will rise to five per cent this year, wages will also be under pressure to increase.

I think we are starting to see some massive evidence of wage pressures that could reinforce some of this inflationary trend as we go into the next year, said Holt in an interview. He said rate hikes could begin as soon as January.

If he is trying to reach wage earners, Macklem’s repeated insistence yesterday that inflation will not rise much and will soon come back down may be falling on deaf ears. Workers who pay little attention to statements by central bankers are much more attentive to rising prices that mean their pay doesn’t go as far.

As Finance Minister Chrystia Freeland noted Wednesday in a question and answer session with the Canadian Chamber of Commerce, during election campaign door-knocking the key thing she found that Canadians demand of their governments and their employers is an adequate standard of living.

If there’s a job and I take that job, can I have a decent life for me and my family? said Freeland.

As the price of everything from food to houses rises by five per cent, it may be hard to make the political case that wage earners should pay for it with a lower standard of living while everyone else gets an increase.

Don Pittis  · CBC News