A top Bank of Canada official has warned that the central bank’s ability to gauge when the economy has reached full employment and interest rates need to rise has become uncertain.
Deputy Governor Lawrence Schembri said policy makers are striving to bring the economy to full capacity with employment at its maximum sustainable level. But measuring that level has become more difficult because of structural changes and the uneven effects of the pandemic on the Canadian labour market.
“Our assessment of labour market conditions and underlying capacity and inflationary pressures is now more difficult,” Schembri said to the Canadian Association of Business Economics. “Consequently, more uncertainty exists around the timing of when the output gap will close and inflation will return sustainably to our 2% target.”
The speech was a reminder to markets that the path to normalization remains fundamentally unknown, contingent on the economic trajectory and health of the labour market. Governor Tiff Macklem gave a similar notice to global investors in an opinion piece published earlier this week in The Financial Times newspaper, in which he pointed out that while the timing of the next rate hike is “getting closer” it will be dependent on economic outcomes.
Altogether, the Schembri and Macklem comments represent an effort by Bank of Canada officials to emphasize critical elements of their current forward guidance, which is not to raise interest rates before capacity is fully absorbed.
Economists now forecast that the Bank of Canada will raise its benchmark overnight policy rate to 1.5% over the next 12 months from 0.25% now.
Schembri warned on Tuesday that the central bank’s projections could change, and policy moves will be outcome dependent.
“There’s a lot of uncertainty about the timing of the closing of the output gap,” Schembri said, in response to a question from the audience. “One should be careful not assuming it’s necessarily going to be Q2.”
Canada reports inflation data for October today (November 17). Economists are predicting annual inflation reached 4.7% last month, which would match the highest level in three decades.