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The Canadian economy is facing two very distinct problems right now.
On the one hand, inflation is high and rising. So far, at least, price increases have been contained to energy. Inflation ticked up to 3.1 per cent last month, but core measures (which strip out more volatile components) remained subdued.
But as we saw in the U.S., the containment doesn’t hold forever — and once price increases spill over into other sectors, it can be tough to rein them back in.
On the other hand, the economy is weak. And we haven’t even really started to get a measure of the impact of the latest tranche of tariffs.
Those two duelling crises pose a difficult riddle for the Bank of Canada.
Weak growth would usually prompt the central bank to cut interest rates to spur some economic growth. But rising inflation makes the bank want to raise rates to slow the economy and keep prices from increasing too quickly.
Two problems — with two solutions in complete contradiction to one another.
Bank of Canada governor Tiff Macklem says while he hopes for a return to a ‘more normal’ Canada-U.S. relationship, he doesn’t anticipate getting back to ‘where we were’ when dealing with an American administration that favours tariffs and protectionism.
One by one, most of the major economic outfits in the country have switched their forecasts. Most now believe that on Wednesday the Bank of Canada will increase its key overnight lending rate.
They all lay out the economics of the matter, but as Frances Donald and Nathan Janzen from RBC Economics remind us, the bank is seeing this year’s surge in inflation through the prism of the last surge — the pandemic shock of 2022 to 2023.
“The cautionary lessons of the post-pandemic inflation surge … demonstrated how supply-side shocks and persistent cost pressures can overwhelm an economy surprisingly quickly,” wrote Donald and Janzen in a note to clients last week.
So, most economists now believe the bank will increase rates, even though they don’t all feel the bank should make such a move.
Donald and Janzen say a quarter-point increase won’t materially move the needle on where they think the economy is headed. (They had, after all, built their forecast on the assumption that rates were going to rise next year.)
“Ultimately, the signal of a rate hike on Oct. 28 has a larger meaning we shouldn’t ignore: Central banks do not have the same patience for inflation they might have had in the past, and are willing to act pre-emptively to guard against it,” they wrote.
If we could wave a magic wand, we would probably like the economic data this week to come in opposite order. We have the interest rate decision on Wednesday and GDP numbers on Friday.
GDP stalled in July (zero per cent growth) and the economy is expected to have grown by 0.1 per cent in August. But new tariffs kicked in that month, so the risks to the forecast remain firmly planted on the downside.
Uncertainty is the new … everything.
The Canadian economy and the Canadian consumer have both proven themselves to be far more resilient than expected. But each new obstacle takes a fresh swipe out of the Canada’s potential growth.
On the upside, we will also get an update on the Bank of Canada’s forecasts this week. The Monetary Policy Report is the central bank’s deep dive into where it sees the economy headed.
