Central banks won't let stagflation take hold, Bank of Canada governor says

[OTTAWA] Hours after delivering the biggest interest-rate hike in 22 years in Canada, Tiff Macklem had a message for investors: There's no reason to worry about inflation getting out of hand.

While there is plenty of uncertainty in the global economy, the Bank of Canada governor told Bloomberg News he's quite certain that policymakers will be able to avoid a return of 1970s-style stagflation.

Macklem said the world's central bankers have learned the hard lessons from letting inflation get too high. They're adjusting policy quickly to avoid a scenario where price pressures remains elevated and the global economy sinks into a recession, he said in an interview.

"A lot has changed since the 1970s," said Macklem, who earlier Wednesday (Apr 13) delivered a half-percentage point rate increase in a bid to wrestle inflation down from a 3-decade high. "Central banks are going to be much more ahead of it than they were."

In Canada, that means normalising monetary policy "relatively quickly" to keep demand in check and prevent inflation expectations from hardening, he said.

Macklem's decision, which brought Canada's policy rate to 1 per cent, came on the same day New Zealand's central bank lifted its official cash rate by half a percentage point to 1.5 per cent earlier in the day. A hawkish pivot is also expected in the US, where Chairman Jerome Powell and other policymakers have put a half-point hike on the table for the Federal Reserve's meeting in May.

On Wednesday, Macklem also provided guidance on how high interest rates could rise in Canada, saying he expects to see the policy rate to return to more normal settings of 2 to 3 per cent. But if needed, they could go even higher.

"The economy just does not work well when inflation expectations become unmoored when inflation is high and variable," Macklem said. While market-based expectations have risen higher, they're still "consistent" with inflation coming back to the bank's 2 per cent target, he said - adding that "we wouldn't want to see them go further".

Macklem said that while inflation is higher, there's little evidence of recession risk. The Bank of Canada is forecasting robust global growth of 3.5 per cent in 2022, despite the pressures of Russia's war in Ukraine. In Canada, unemployment is at the lowest in more than 45 years and it "doesn't look anything like stagflation", he said.

Central bank officials are predicting real growth of 4.25 per cent this year in Canada and 3.25 per cent in 2023. That's well above the country's long-term potential speed limit. It's also above many of its peers, including the US, which is seen growing by 2.8 per cent this year.

The outperformance is due in part to Canada's resource-based economy being buffered by higher commodity prices stemming from the Ukraine war. But it's also because Canada had more strict Covid-19 restrictions and is emerging from the pandemic more slowly, Macklem said.

In fact, despite some worries, the Bank of Canada was too slow to start tightening policy, Macklem remains optimistic about a soft landing, where higher interest rates do the job of slowing demand without causing a major economic disruption. He declined, for example, to characterize the country's current inflation situation as a crisis.

That optimism hinges on certain assumptions - that supply chain problems will improve, business investment will accelerate and productivity will rise as Covid rules are lifted.

"I do think those assumptions are balanced and are there risks? Yes, there are risks on both sides," Macklem said.

At the same time, he acknowledged that if the central bank is wrong on its supply assumptions, "we're going to have more work to do" on rates.

The big difference today is the Bank of Canada is guided by its 2 per cent inflation target, which was developed partly as a response to the 1970s-era inflation. "It is imperative to keep a focus on price stability because if you lose that, nothing else is going to work," Macklem said. BLOOMBERG


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