The Bank of Canada is pushing ahead with another key rate hike in the face of decades-high inflation rates and record unemployment.
Here’s what you need to know about the link between interest rates, inflation and the labor market.
What is the key rate and what is it used for?
The policy rate, also known as the target overnight rate, is the amount of interest the Bank of Canada charges commercial banks when they lend money to each other overnight to settle balances. dailies. Knowing how much it costs to lend money or deposit it with the central bank helps set the interest rates charged on things like loans and mortgages.
Lowering the policy rate makes it cheaper to borrow and spend, usually during economic downturns when inflation rates are too low, in an effort to create growth. Raising rates has the opposite effect by cooling spending when inflation exceeds the Bank of Canada’s comfort zone, which is between 1 and 3%.
Why are inflation rates so high right now?
One of the main reasons is that the demand for goods like household items exceeds the capacity of manufacturers and supply chains. This has increased the cost of the limited supply of goods, but also the shipping costs which translate into price increases.
But as Frances Donald, Manulife’s global chief economist, noted on Twitter on Tuesday, “we’re moving from COVID inflation to conflict inflation.” Russia’s unprovoked invasion of Ukraine has driven up oil and food prices, leading to higher prices at the pump and in grocery stores. It’s easy to avoid spending on cars, home improvements and fitness equipment, Donald wrote, but not on food and energy.
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“Conflict inflation is going to be lower in headlines going forward, but more painful for growth,” she wrote.
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How does the labor market fit into the inflation picture?
The concern of economists, and the central bank by extension, is that people are starting to expect inflation to stay higher for longer. Companies would start working in faster price increases to stay ahead of cost increase expectations. Workers would demand wage increases to keep up with the cost of living. A spiral could ensue where wages become a key driver of rising prices.
Average hourly wages, as tracked by Statistics Canada, have increased in recent months, although they still lag the overall rate of inflation. But wages could rise faster as companies try to fill more than 900,000 job vacancies in January, according to the most recent figures available from Statistics Canada. The shrinking pool of available workers is adding to the stress: the unemployment rate hit a historic low of 5.3% last month.
Why would the Bank of Canada monitor unemployment?
The Bank of Canada’s inflation-targeting mandate, which the federal government renewed in December, included language on monitoring the labor market. The central bank may decide to allow inflation to approach either end of its 1-3% target range for short periods, as it determines when the labor market peaks potential.
Other central banks, such as the US Federal Reserve, more explicitly target maximum employment as part of their mandate.
The Bank of Canada has expressed concerns about the current tight labor market, which would lead to a drag on the economy. But if the central bank leans heavily, mortgage rates, for example, could rise faster than some households can afford.
“And if enough of them were to significantly slow down their spending, it could affect the whole economy, for example by slowing growth or increasing unemployment,” Deputy Governor Sharon Kozicki said in a speech on Tuesday. last month.
Market and activity report – April 13, 2022
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