GRI hosted Derek Holt, Vice President and Head of Capital Markets Economics at Scotiabank, who provided an in-depth assessment of Canada’s inflation and its expected path in 2022 and beyond.
Derek began his presentation with an overview of how the massive monetary support of the Bank of Canada (BoC) and other central banks was essential during the severe economic contraction from COVID-19. Together with fiscal support, interest cuts and quantitative easing were decisive in preventing a much more severe recession and potential depression. However, the BoC and other central banks saw the pick up in inflation by the spring and summer of 2021 as temporary or transitory. As price pressures accelerated in late 2021 and early 2022, central banks have been playing catch-up with inflation and inflation expectations. In Scotiabank’s view, the BoC should have signaled by mid 2021 that economic conditions had changed to condition people to expect monetary tightening and arguably deliver rate hikes towards the end of 2021. The result of delaying monetary restraint is the need for more dramatic interest rate increases in 2022. Among the reasons that inflationary pressures were misread are that there may have been too many measures used by the BoC in gauging and attempting to forecast inflation.
Looking ahead, Canadian inflation is forecast to remain relatively high: Scotiabank currently expects annual inflation at six percent for 2022 and then declining to just over three percent for 2023, with those numbers being on the higher end of the forecasting community’s consensus. Scotiabank’s outlook is that it will take until 2023 to return to a more neutral nominal policy rate around three percent, and real policy rate that is no longer significantly negative.
With respect to economic growth, Derek highlighted recent data showing that Canadian households are better positioned to absorb price and interest rate increases given wage gains over the latest 12 months and high personal savings rates. However, with Canadian businesses and consumers expecting inflation to persist at levels above the BoC’s two percent target, the BoC is facing a tough challenge. Monetary policy needs to actively address the risk of individuals and firms’ expectations of inflation becoming self-fulfilling prophecies. As a result, the BoC needs to tighten policy more than the market consensus to contain wage and price expectations.
Vice President and Head of Capital Markets Economics, Scotiabank