Tackling inflation without killing growth

As the Bank of Canada prepares its rate decision on Wednesday with inflation at multi-decade highs, CIBC chief economist Avery Shenfeld is optimistic that rising prices can be tackled without destroying growth.

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According to Shenfeld, a lot of the trouble lies in the fact that the world’s production and distribution engines are still clogged with Covid-19 cases around the world.

“As that eases, we expect that the availability of goods, and therefore their prices, will adjust and some of the inflation we see will vanish,” he said in a Feb. 15 interview.

Shenfeld said he expects the Canadian economy to grow by about 3.5% this year, with growth slowing to around 2% by 2024 as central banks raise interest rates to tackle inflation.

Inflation, which in January hit 6.1% in Canada and 7.5% in the U.S. compared with a year ago, is expected to remain high and even accelerate in the coming months, especially with Russia’s invasion of Ukraine likely disrupting oil and gas exports. The invasion and its uncertain impact on markets and inflation have increased pressure on central banks and made the pace of rate hikes less clear.

Speaking before Russian’s invasion of Ukraine, Shenfeld said the timing of rate hikes is hard to predict. The Bank of Canada’s next rate announcement is on Wednesday and the Federal Reserve meets March 15-16.

“They may well move in early March if Covid has eased up enough at that point to make that a reasonable decision, but certainly we expect rates to rise by about a full percentage point in both the U.S. and Canada this year,” he said.

Both the U.S. and Canadian economies are reaching the point where labour markets are tight, and Shenfeld said there’s an element of inflation that can’t be addressed without taking steps to slow economic growth.

Further rate hikes into 2023 will be needed, with short-term interest rates in both countries likely to be a bit above 2% in 2024, he said.

“So that’s still a gradualist path and if the central banks do this gingerly, they won’t be destroying growth in either country — only moderating the pace in order to prevent the unemployment rate from dropping to unsustainably low levels that would keep inflation elevated,” he said.

Regardless, Shenfeld doesn’t think the economy will see a repeat of the persistent inflation or stagflation seen in the 1970s.

“We’ve learned a lot about how to manage economies to avoid that set of outcomes over the past decades,” he said.

One factor that Shenfeld said the Bank of Canada will have to consider more than the U.S. is Canada’s higher household debt relative to income. But for Canadians who are carrying a lot of debt, Shenfeld said “misery loves company.”

“The fact that there are other Canadians in a similar position makes it less likely that the Bank of Canada will overdo it on rate hikes and cause too much pain for those indebted Canadians,” he said.

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