Bank of Canada deputy governor warns of persistent supply chain constraints

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The Bank of Canada is warning that global supply chain disruptions could persist for longer than expected, creating significant uncertainty about the path of inflation.

In a virtual speech on Thursday, central bank deputy governor Toni Gravelle said that continuing disruptions to global manufacturing and transportation have made it difficult for policy makers to assess how long inflation will remain above the bank’s target range of 1 per cent to 3 per cent.

He said the bank still expects the rate of inflation, which hit 4.7 per cent in October, to decline next year. But he warned that the longer supply chain problems persist, the greater the risk that the current spike in consumer prices will feed into “a second round of price increases,” this time driven by wage increases and heightened inflation expectations among businesses and consumers.

The speech followed a rate decision on Wednesday in which the bank left monetary policy unchanged. It kept its overnight rate at 0.25 per cent and reiterated that it expects to start raising interest rates in the middle quarters of next year.

The bank is entering a period of sustained interest-rate hikes, as it looks to unwind the ultra-easy monetary policy it has maintained since early in the pandemic. Analysts widely expect the increases will start next April, and financial markets are pricing in as many as five rate hikes next year.

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Mr. Gravelle’s comments on Thursday were “notably more hawkish than Wednesday’s policy statement,” Andrew Kelvin, chief Canada strategist with Toronto-Dominion Bank, wrote in a note to clients.

“We continue to look for the BoC to hike rates in April, but the deputy governor’s comments around inflation risks and hints of supply side revisions in the January [monetary policy report] keep the door open to an earlier liftoff, and should put more focus on economic data over the coming weeks,” Mr. Kelvin wrote.

The speech, delivered virtually to the Surrey Board of trade, is the central bank’s clearest description to date of how it understands supply chain bottlenecks and their impact on inflation. Mr. Gravelle said much of the current bout of high inflation is the result of strong demand for goods – many of which are manufactured and shipped from Asia – running into significant supply chain snarls.

The bank expects these issues to resolve over time, as consumers shift from buying physical goods back to services – such as travel and restaurants – and companies take advantage of new opportunities posed by supply bottlenecks. But Mr. Gravelle said the unusual nature of the economy during the pandemic makes it difficult to know when the problems will begin to ease.

“While there are early signs that some supply constraints are easing, such as for semi-conductors, most constraints remain largely unresolved,” Mr. Gravelle said.

“Moreover … the floods in British Columbia are likely to worsen backlogs at the Port of Vancouver and disrupt shipping by rail and truck,” he said.

He also highlighted the risks surrounding the Omicron variant, which could affect both economic growth and inflation.

“The new variant has triggered a sharp drop in oil prices in the near term. But further out, given its potential to restrain the transition to more balanced consumption patterns between goods and services, it could exacerbate upward price pressure on the goods that are experiencing supply constraints,” he said.

The speech was partly a defence of the central bank, which has changed its economic and inflation forecasts multiple times over the past year. That’s led critics, including opposition politicians, to say the bank has lost credibility in its projections.

Mr. Gravelle noted that the central bank adjusted its forecasts as economic disruptions – from a dearth of semi-conductor chips to slowdowns in container shipping – became clear. He acknowledged, however, that the economic models the bank relies on for forecasting are having a hard time dealing with a global shock to supply and demand.

“Given that there is no historical precedent to the sudden closing and reopening of the economy, our models were not built to capture the many economic forces that arose from the pandemic,” he said.

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