By Julie Gordon and Fergal Smith
OTTAWA (Reuters) – A rally in commodities triggered by Russia’s invasion of Ukraine will push Canadian inflation higher for longer, with the headline rate now peaking at 6% or above, forcing the central bank to raise interest rates more aggressively, economists told Reuters.
Canada’s inflation rate has already jumped well above the 5.1% forecast by the Bank of Canada for the first quarter of January, underscoring the difficult road ahead to bring price growth back to the 2% target .
Chart: Canada annual inflation rate: https://graphics.Reuters.com/CANADA-ECONOMY/INFLATION/egpbkqrxrvq/chart.png
The central bank will have to balance efforts to rein in soaring prices against the risks that soaring mortgage debt will make the Canadian economy more sensitive to interest rate hikes than before the coronavirus pandemic.
Some investors worry that the BoC will halt the economic expansion if it tightens too quickly.
A Reuters survey of economists from five major financial institutions and a consultancy showed that most now expect the Bank of Canada to raise borrowing costs four to five times in 2022, bringing its key rate to 1.25% or 1.5% by the end of the year. Scotiabank is forecasting a year-end policy rate of 2.5%.
The latest Canadian inflation data on Wednesday surprised on the upside, with the consumer price index hitting a new 30-year high of 5.7% in February. The jump was fueled by broad gains across all sectors.
All six economists surveyed now see inflation peaking at or above 6% in the coming months, with their end-of-year forecasts ranging from 3.3% to 5.8%. The Bank of Canada in January forecast inflation of 3.0% in the fourth quarter.
“The rise in commodity prices we’ve seen over the past couple of weeks – that’s something a central bank would normally want to look at,” said Josh Nye, senior economist at RBC Capital Markets, who was among the questioned person.
“But with inflation already so much above the Bank of Canada’s target, they said they are more concerned about upside surprises than downside inflation surprises.”
The central bank raised its benchmark rate to 0.50% from 0.25% this month, its first increase in three years. Bank of Canada Governor Tiff Macklem said more rate hikes were coming and he left the door open for a rare half-percentage-point hike.
Money markets see a roughly 50% chance of a bigger rate hike when the central bank releases its next policy move on April 13. It has been nearly 22 years since Canada last saw a 50 basis point rate hike.
The conflict in Ukraine and subsequent sanctions against Russia have disrupted global supply chains, driving up the prices of many commodities. Russia is one of the largest energy producers in the world, and both Russia and Ukraine are among the top grain exporters.
Nye estimated that the surge in oil prices since late February alone would add about three-quarters of a percentage point to Canada’s CPI.
US inflation is expected to average 7.7% this quarter, according to a Reuters poll of 69 economists last week, up from 7.1% forecast in February.
With Canada’s economy firing on all cylinders, its central bank must now act forcefully on interest rates to rein in price spikes, said Derek Holt, head of financial markets economics at Scotiabank.
“Given the Bank of Canada’s lag on the inflation curve, it needs to do something more convincing in order to demonstrate that it takes its inflation mandate seriously,” said Holt, who also participated in investigation.
Still, the central bank will have to consider the potential for the war to slow global economic activity, while balancing inflationary pressures stemming from supply shortages due to the latest COVID-19 restrictions in major Chinese manufacturing hubs.
“There is the likelihood of further supply chain issues for other goods which will also keep inflation higher than expected,” said Andrew Grantham, senior economist at CIBC Capital Markets, who was among those interviewed.
Chart: Canadian Interest Rate Forecast: https://graphics.Reuters.com/CANADA-ECONOMY/INFLATION2/mypmnxdnnvr/chart.png
(Reporting by Julie Gordon in Ottawa; Editing by Denny Thomas and Paul Simao)
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