The BoC will consider the labor market in decisions to combat inflation

Canada’s central bank will aim to keep the annual rate of price increases at its historic target rate, but will now more formally take into account the health of the labor market as part of its inflation targeting regime.

A new framework agreement between the federal government and the Bank of Canada announced Monday has an annual inflation rate of two percent at its heart.

However, the central bank will now also consider employment levels and how close they are to the highest level they can reach before fueling inflation when setting its trend-setting interest rate.

The Governor of the Bank of Canada, Tiff Macklem, and the Minister of Finance, Chrystia Freeland, emphasized that there were no substantial changes in the bank’s march orders, and that the consideration of employment does not constitute a dual mandate to achieve two different objectives, a measure that was under consideration for the mandate. .

The two framed the deal as a codification of the Bank of Canada’s interest in a healthy job market, something the bank has emphasized during the pandemic when explaining its moves.

“Monetary policy works best when people understand it,” Macklem said, “and really, this agreement clarifies our objectives and clarifies how we have and can use the flexibility that is built into our framework.”

Under the new agreement, the Bank of Canada can decide to allow inflation to stay closer to either end of the bank’s target range of one to three percent for short periods, as it determines when the labor market reaches its maximum potential. .

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You also have the flexibility to keep your key interest rate as low as possible for longer periods to help the economy recover from a recession.

Since 1991, the Bank of Canada has targeted an annual inflation rate of between one and three percent, often reaching a sweet spot of two percent.

Even under those previous mandates, the health of the job market was a factor in decisions about whether to lower or raise rates, said BMO’s Canadian director of rates Benjamin Reitzes.

“For example, inflation is near five percent and the slack in the labor market has been a key reason why the (Bank of Canada) has kept policy rates at the lower limit,” he wrote in a note.

The Bank of Canada’s key policy rate since the start of the pandemic has been 0.25 percent, and it was cut there to boost spending during the COVID-19-induced recession and subsequent rally. As it stands, the bank doesn’t see a rate hike until April 2022 at the earliest.

Changes to the Bank of Canada’s overnight interest rate target influence prime rates at the country’s large banks that are used as a benchmark for loans such as variable rate mortgages and home equity lines of credit. Changes in the rate can also influence bond yields, which can cause changes in fixed-rate mortgages and other loans.

Under Monday’s deal, the central bank said the rate could bottom out more often and stay that way longer if the bank believes it will help bring inflation back to target.

Sometimes a longer low-rate environment may be necessary, the bank said, even if the likelihood of inflation exceeding the two percent target increases as the economy recovers.

Rate hikes could be more gradual than in the past as the bank finds out whether it has correctly estimated the full potential of the labor market, meaning inflation could rise above the bank’s target again.

“This is reason to think that inflation, on average, will be higher in the next few years than in the last decade, although not dramatically,” said Stephen Brown, Canada senior economist at Capital Economics, noting that the inflation has averaged 1.7%. since the global financial crisis.

The bank noted that figuring out when the country has reached “maximum sustainable employment” may be “impossible” because it cannot be pinned down to a single number, and is complicated by a graying workforce and increased digitization.

The bank plans to outline which labor market markers it is monitoring and detail them as part of its regular interest rate announcements.

The agreement also describes how the bank should consider climate change in its policies, although it lets governments meet emissions targets. “Monetary policy cannot directly address the threats posed by climate change,” the statement read, the latter adding that economic models must take into account their effect on the financial system.

Greenpeace’s Alex Speers-Roesch said that, on the contrary, central bank policy can help combat climate change. He noted the bank’s option to buy more environmentally friendly assets, which the Bank of Canada is considering.

This Canadian Press report was first published on December 13, 2021.