Is the Bank of Canada getting complacent?

As expected, the Bank of Canada kept its interest rate settings unchanged today, with the overnight rate staying at 0.25 percent. The Bank also committed to maintaining its quantitative easing (QE) program at the current level of C$ 4 billion per week. There was no press conference this time, so the press release itself provides the only evidence we have of the Bank's current thinking. 

In general, the Bank believes that both the real economy and inflation are evolving in line with the projections in its last Monetary Policy Report in October.  The timing and scale of the uplift expected from the early approval of COVID vaccinations remain uncertain, and further restrictions and lockdowns may set back recoveries in Canada and elsewhere.  Measures of core inflation are below the 2 percent target, and the presence of substantial slack in the economy is expected to weigh on inflation for some time. Based on this, the Bank intends to keep interest rates at current levels and maintain its QE program until inflation is sustainably above the 2 percent target, something it does not expect to happen until 2023. 

Even if we allow that most of this is true, is it too soon to suggest that the Bank may be underestimating the risk that inflation could start to move higher sooner than it expects? Consider food prices, for example: this article suggests that household grocery bills could rise by 3 to 5 percent in 2021, reflecting the impact of both COVID (as labour shortages and logistics issues push up production costs) and climate change. This is the fastest growth that the Canada Food Price Report has projected in its eleven year existence. The Bank of Canada might prefer to "look through" such an increase, but it is not at all clear that Canadians or their politicians will be prepared to do the same. 

Then there is the massive COVID stimulus to consider. In last week's Fall Update, Finance Minister Chrystia Freeland noted that a significant proportion of the various emergency benefits that the Government has paid out has gone into savings accounts, rather than being spent immediately. She referred to this money as "pre-positioned stimulus" for the post-pandemic recovery.* With vaccines on the horizon, there is every reason to expect that as we move through 2021, much of that money will flow back into the economy, as COVID fatigue gives way to a tsunami of pent-up spending on restaurants, travel and just about everything else.

It seems inevitable that this spending will start to push up inflation, as businesses take advantage of the boost in consumption to rebuild profit margins and balance sheets. This creates an issue for the Government in its management of fiscal policy: it is promising C$ 75-100 billion in new spending to jump-start the economy, but what happens if the "pre-positioned stimulus" makes that largely unnecessary? It also, of course, creates an issue for the Bank of Canada, if inflationary pressures begin to mount all across the economy well before 2023. The Bank's current forecast may well turn out to be correct, but there are good reasons to think that the inflationary risks may now be biased to the upside.  

* This is presumably more palatable politically than admitting that the Government gave a lot of money to people who did not actually need it.