Bank of Canada's Paul Beaudry suggests benchmark rate could top 3%

According to the Bank of Canada, it will need to raise its benchmark interest rate to three per cent in order to keep inflation under control.

The benchmark rate in Canada increased by half a point on June 1.

That is a quarter point shy of the pre-pandemic rate of 1.75 per cent, which was as high as policymakers were able to push the rate. The economy never really gathered significant momentum over the decade that followed the financial crisis, which left central bankers looking over their shoulders for a return to deflation.

In a speech on June 2, Paul Beaudry said that the situation today is completely different.

Between 2010 and 2020 the consumer price index never increased more than 3%. The April increase was the second biggest since the early 1980s. Since 1991, when the Bank of Canada adopted the index as its guide for policy, inflation has exceeded the high end of the comfort zone.

Beaudry said that price pressures are broadening and inflation is likely to go higher before easing.

The Bank of Canada observed this week that the inflation gauge it watches to separate core prices from swings in the cost of food and energy now exceeds three percent. It is a problem for households who have to deal with higher costs of living. The credibility of the Bank of Canada is at stake as they have a mandate to keep the consumer price index in check.

The Bank of Canada hardened its message this week, even if it meant testing the country's willingness to accept an economic downturn to contain upward price pressures.

The Bank of Canada suggested that its latest economic outlook probably understates inflation, as well as acknowledging that it is worried about inflationary expectations becoming "entrenched."

Beaudry said in his speech that the policy rate might need to go outside its neutral range to restrain economic growth. It's a theoretical rate that doesn't stoke or choke growth. According to the Bank of Canada, Canada's neutral rate is between 2% and 3%.

The spread of inflationary pressures suggests that they will need to be stopped.

Beaudry said that this raises the likelihood of raising the policy rate to the top end or above the neutral range to bring demand and supply into balance.

The Bank of Canada will need to raise its benchmark rate to get inflation under control, according to many on Bay Street. The central bank was late in starting to raise interest rates and will have to work harder to keep inflation under control.

Beaudry said policymakers will present an initial analysis of their forecasting errors when they release their next quarterly economic outlook.

It is possible that the central bank is trying to learn from its mistakes in order to shore up confidence in the institution. The central bank was criticized for not simply making an honest mistake, but for being blinded by arrogance.

Beaudry said the miss on inflation was related to inflation. He said in the speech that the kind of spikes in commodity prices that came with the recovery from the Pandemic tend to be temporary. With the economy recovering from an epic crash and waves of COVID-19 still a threat to growth, policymakers decided to stick to their guns.

Beaudry said that the risk was appropriate given the slack in the economy and the view that the supply-driven sources of elevated inflation would likely prove temporary.

The situation today is not the same. Canada's economy is in demand. The initial disruptions to international supply chains have persisted longer and expanded more than we anticipated.

The risk of inflation expectations de-anchoring and high inflation becoming entrenched has increased.

That is a terrible nightmare for a central bank. The phrase "lower for longer" was used for a long time. It's time for a new one.

Kevin Carmichael can be reached via email at kcarmichael@postmedia.

The Financial Post is part of Postmedia Network Inc.

There was an issue with signing you up. Try again.