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Bank of Canada Ready to Raise Rates if Inflation Exceeds 2% Target

Canadian inflation risks getting stuck significantly above the Bank of Canada's 2% target. According to Governor Tiff Macklem, if this occurs, the central bank is prepared to increase interest rates further.

Tiff Macklem
Tiff Macklem

High-Interest Rates Due to Labor Market and Services Prices

In the previous month, the Bank of Canada kept its key overnight interest rate at 4.50%. The bank noted that rates must remain high due to wage pressure in a tight labor market and persistent service prices.

Baseline Scenario and Potential Inflation Challenges

The bank's baseline scenario predicts a softening labor market as growth slows, reducing wage pressure and business price-setting behavior. However, Macklem acknowledged the risk of inflation remaining above the 2% target if adjustments stall.

Further Rate Hikes in Response to Entrenched Inflation

According to Governor Macklem, if the Bank of Canada sees signs of inflation becoming entrenched above 2%, it is prepared to raise interest rates further.

Inflation Expectations and Economic Growth

The bank anticipates inflation falling to 3% this summer as the economy continues modest growth, followed by a slower and more uncertain decline to 2% by the end of 2024.

Addressing Global Financial Instability Risks

Macklem also discussed the potential impact of recent financial instability in the U.S. and Europe on Canada. While market stress has had a muted effect, more significant spillover effects could occur if global financial stress proves pervasive.

Tools to Provide Liquidity in Severe Stress Situations

The Bank of Canada has tools to provide liquidity and restore price stability if more severe financial stress emerges in the country, Macklem reassured.