Canadian inflation is not likely to go back to the central bank’s 2% target until 2024 after probably soaring in June, as less volatile items like rent and wages replace energy as core sources of price pressure, analysts say.
In an attempt to return inflation to target, since March the Bank of Canada (BoC) has lifted its benchmark interest rate by 225 basis points to 2.50%, including a full-percentage-point move in its previous policy decision last month, the largest single rise by a G7 country in this economic cycle.
A gradual grind back to target could make the central bank increasingly reluctant to turn to interest rate cuts in 2023 if the economy moves into recession as some analysts anticipate. In early August, expectations established that the central bank would be slashing rates as soon as next March.
“Even with the economy likely to see a mild recession next year, we think it will take until 2024 to get inflation back to target, or reasonably close,” said Josh Nye, senior economist at Royal Bank of Canada.
The Bank of Canada’s most recent forecast last month, was for inflation to go back to 2% by the end of 2024 and for the economy to evade a recession.
Canadian inflation shrank to 7.6% last month on falling gasoline prices, dropping from a nearly four-decade high of 8.1% in June, but measures of core price pressures that divest the most volatile components, such as energy, continue to rise.
The problem is that rises in slower-moving factors of inflation like rent and wages are likely to be constant, or risky, even as commodity-price gains and some supply constraints prompted by the Ukraine war ease and the COVID-19 pandemic, analysts say.
Doug Porter, a chief economist at BMO Capital Markets, said in a note:
“The biggest theme from this latest (inflation) reading is a significant rotation in where the most intense price pressures are coming from. The Bank can scarcely back down anytime soon, as it has a long-term battle on its hands reining in 5% core inflation.”
Investors seem to have taken note, with money markets currently anticipating the central bank’s benchmark interest rate to climb to almost 3.75% in the first quarter of 2023 and remain near that level through much of 2023.
The Federal Reserve could also be encountering a lengthy battle to return inflation to target. But it has a dual mandate of price stability and employment, unlike the single goal of bringing down inflation aimed for by Canada’s central bank.
Jimmy Jean, the chief economist at Desjardins Group, stated:
“The BoC is most likely biased towards taking the risk of overtightening rather than under-tightening until they see enough evidence that demand is cooling.”