Canada’s inflation under the G7 is low. Why would the BOC raise rates?

Canada’s inflation rate is one of the lowest of the G7 countries, after falling significantly in May – just in time, some fear, for another rate hike by the Bank of Canada in July.

Which begs the question: If inflation falls, should banking governor Tiff Macklem really raise interest rates?

The consumer price index — a broad measure of inflation — fell from 4.4 percent in April to 3.4 percent in May, Statistics Canada said Tuesday. That’s a welcome drop, economists say, moving closer to the Bank of Canada’s inflation target of two percent.

According to May’s inflation figures, Canada is below most G7 countries. The UK takes first place with an inflation rate of 8.7 percent, followed by Italy at 7.6 percent, Germany at 6.1 percent, France at 5.1 percent, the US at 4 percent and Japan at 3. 2 percent.

“Central banks have a hard and fast 2% target and are committed to it,” said David Macdonald, senior economist at the Canadian Center for Policy Alternatives. “It’s two percent or bankrupt.”

But May’s inflation numbers could prompt the bank to raise interest rates in July, he said, as inflation is expected to fall to just under 3 percent by the end of June.

“There’s a lag time to see how interest rates affect the economy, usually by 18 months to two years,” Macdonald said. “We haven’t seen the full impact yet.”

Last March, the bank embarked on an aggressive rate hike campaign to curb inflation, which rose to 8.1 percent. In several steps, the bank raised its main overnight interest rate from 0.25 percent to 4.75 percent.

“But will it be a soft landing?”

The real question is how quickly can the centre-back reach his 2% goal and is he slamming on the brakes too hard, said Walid Hejazi, a professor at the University of Toronto’s Rotman School of Management.

“There is consensus that there will be a recession, but will it be a soft landing?” he said. “The longer inflation is ingrained in the economy, the harder it is to reduce it.”

An economic soft landing — where the bank raises interest rates and lowers inflation without triggering an economic downturn — is still on the table, but a harder landing is also on the horizon, experts say.

Core inflation — inflation excluding energy and food prices — is still high, Hejazi said, and while on a downward trajectory, it is still not low enough to interrupt rate hikes.

According to a recent report by the International Monetary Fund, “inflation has become a clear and current danger for many countries,” due to rising commodity prices, supply and demand imbalances and the war in Ukraine. As a result, the IMF predicts that global inflation will remain high for “much longer”.

“There is an increasing risk that inflation expectations will drift away from central bank inflation targets,” the report said, “prompting a more aggressive tightening response from policymakers.”

Douglas Porter, chief economist and managing director of BMO Financial Group, said that while Canada is among the most G7 countries, there are other countries in Europe such as Spain, Denmark, Switzerland and Greece that have lower inflation rates than Canada.

“We are slightly below average, but we are not in the safe zone,” he said. Canada has fallen significantly from inflation of 8.1 percent in June 2022, but the current inflation rate is still too high for the bank.

“We’ve generally done a little bit better than other countries,” Porter said, “but we shouldn’t overdo it.”

With files from Josh Rubin.

Correction — June 30, 2023: The consumer price index fell from 4.4 percent in April to 3.4 percent in May. An earlier version of this article erroneously stated that the rate in May fell from June.

Clarrie Feinstein is a Toronto-based business reporter for the Star. Reach Clarrie via email: clarriefeinstein@torstar.c

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