Macklem says Bank of Canada needs to raise rates to put a lid on inflation expectations

Canada's top central banker says the first of severalrate hikes from the Bank of Canada is aimed at staving off aproblematic economic scenario that could be more costly tohouseholds than the double-whammy of higher inflation and interestrates.

Speaking to reporters Thursday, Governor Tiff Macklem looked backa half-century ago to the economy of the 1970s .

He said during that time consumers felt like they were beingripped off as prices rose and wages didn't keep up and labourstrife followed. The economy doesn't work well when people believeinflation will stay higher for longer, Macklemsaid.

To avoid a repeat of that scenario, the bank must act to lowerinflation through measures like Wednesday's quarter-point rate hike,which shows Canadians their concerns are being taken seriously.

Inflation currently sits at a three-decade high and is set torise further on the back of ongoing supply chain issues and risingglobal oil prices that make transporting goods and food evencostlier.

As the pandemic eases, so too should the impact on supply chains,Macklem said.

"Provided we keep inflation expectations well anchored, as thosethings work out, inflation should come down," hesaid duringan afternoon newsconference following his remarks.

"But if we let inflation expectations become unmoored, then whenthose supply constraints ease, inflation won't come back down, andit'll be much more costly to get it back down."

Slashed rate in March 2020

The Bank of Canada raised its target overnight rate to 0.5 per cent on Wednesday, increasing it from its emergency low by one-quarter of a percentage point.

Wednesday's move marked the first increase since the Bank of Canada dramatically slashed the trend-setting rate to 0.25 per cent in March 2020 as a buttress against the economic fallout at the onset of the COVID-19 pandemic.

What has followed is an economic recovery. Macklem says after a solid end to 2021 when the economy grew at an annual rate of 6.7 per cent, the central bank now sees growth in the first quarter of 2022 to be stronger than previously forecasted.

The bankrevised up its outlook for inflation, which is running at a three-decade high and is also hotter than the bank expected six months ago.

WATCH | Bank of Canada raiseskey interest rate inhopes of curbing sky-high inflation:

Bank of Canada hikes interest rate in attempt to curb inflation

2 years ago

Duration 2:01

The Bank of Canada is raising interest rates for the first time since 2018 to try to curb inflation, but the rate hike could add to the financial strain of people already struggling.

During a speech to the CFA Society Toronto, Macklem said higher oil prices have contributed to inflation by increasing transportation costs, which in turn raiseprices on consumer goods, including food. Grocery prices in January were up 6.5 per cent year-over-year.

Concerns inflation could get worse

There has also been a global shift during the pandemic fromservices to goods, which have been harder to come by through snarledsupply chains that have pushed up everyday prices on a broaderselection of everyday goods

Macklem said this broadening in price pressures is a big concernand makes it more difficult for Canadians to avoid inflation, nomatter how prudent they are as shoppers.

Although the bank can't control global inflationary pressures caused bysupply chains and Russia's unprovoked invasion of Ukraine, Macklemsaid the increased cost ofborrowing, which is under its control,should dampen spending growth.

That in turn will curb demand, keeping it from runningsignificantly ahead of supply and further fuelling an already highinflation rate.

"For households and businesses that are already feeling thepinch of inflation, the higher cost of borrowing can be doublypainful," Macklem said in his speech. "But tighter monetary policyis necessary to lower the parts of inflation that are driven bydomestic demand."

Macklem said the bank's benchmark rate will need to rise further,including a potential for a half-percentage-point hike if seniordecision makers feel they need to move quicker or more forcefully.

He also said the central bank will eventually stop purchasingfederal bonds as part of what's known as "quantitative tightening"that will have the effect of putting further upward pressure oninterest rates.