Bank of Canada’s Tiff Macklem says overheating labour market must cool to fight inflation

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Bank of Canada Governor Tiff Macklem says unemployment needs to rise in order to slow down inflation, although he is not expecting joblessness to increase as sharply as it did in previous recessions.

In a Thursday speech in Toronto, Mr. Macklem said Canada’s labour market is overheating, with businesses struggling to find workers and unemployment near a record low. This is feeding through into inflation, as companies bid up wages to compete for employees.

“We need to rebalance the labour market,” Mr. Macklem said. “This will be a difficult adjustment. We want to do this in the best way possible for Canadian workers and businesses.”

He made his comments after a blowout jobs report last Friday. Employment in Canada jumped by 108,000 in October, recouping all of the jobs lost during the summer slowdown, while the rate of unemployment remained steady at 5.2 per cent.

The strength of the labour market is a challenge for the central bank. Mr. Macklem and his team are actively trying to slow down Canada’s economy, rapidly increasing interest rates with the goal of curbing demand for goods and services and slowing down price increases.

Tight labour markets tend to be good for workers, who see their bargaining power increase and find it easier to switch jobs. The average hourly wage rose 5.6 per cent in October compared to the previous year – high by historical standards, although still below the rate of inflation. But rising labour costs can add to inflationary pressures, particularly in the service sector, as companies raise prices to cover their expenses.

“The unemployment rate in June hit a record low [of 4.9 per cent] – and while that seems like a good thing, it is not sustainable,” Mr. Macklem said at an event hosted by the Public Policy Forum. “The tightness in the labour market is a symptom of the general imbalance between demand and supply that is fuelling inflation and hurting all Canadians.”

This narrative has been criticized by unions and left-leaning politicians, including NDP Leader Jagmeet Singh, who argue that the central bank is putting the burden of reducing inflation on workers. They have called on the Bank of Canada to stop raising interest rates.

The central bank has increased its benchmark rate six times since March, in one of the fastest rate-hike cycles on record. The policy rate is now at 3.75 per cent, up from 0.25 per cent at the start of the year. Mr. Macklem said again on Thursday that interest rates likely need to keep rising. Financial markets expect further increases in December and January.

“Even though [Mr. Macklem] mentioned that there are pockets of weakness in the labour market, there is a long way to go to restoring balance,” Toronto-Dominion Bank senior economist James Orlando wrote in a note to clients. “This is why markets are expecting more from the BoC over the coming months, with the policy rate expected to reach 4.25 per cent in early 2023.”

Higher interest rates are starting to slow interest-rate-sensitive sectors of the economy, such as construction and manufacturing. The bank said in its economic forecast in late October that it expects the Canadian economy will “stall” in the coming months, posting near-zero GDP growth in the next three quarters.

That means unemployment will rise, Mr. Macklem said. But he argued that joblessness may not increase as much as in past recessions.

“Typically if you look at recessions since the 1980s, unemployment has gone up about 3 to 6 percentage points. We’re talking about something considerably less than that,” he said at a news conference after the speech.

One potential mitigating factor is the elevated level of job vacancies, he said. Companies were looking to hire for nearly one million unfilled positions in August, according to Statistics Canada.

The Bank of Canada is hoping that these unfilled positions will act as a cushion for falling labour demand. The idea is that companies will take down help-wanted signs as the economy slows, without also laying off large numbers of workers.

This argument is not without its critics, including prominent economists such as former U.S. treasury secretary Larry Summers and former International Monetary Fund chief economist Olivier Blanchard, who have argued that central bankers are being overly optimistic. Mr. Macklem himself acknowledged that a fall in vacancies could still hurt workers.

“That doesn’t mean that this is going to be painless. If you got less vacancies, if you’re looking for a job, it’s probably going to take you longer to find a job, so that means the unemployment rate will go up,” he said.

Tight labour markets are a product of both demand and supply. Canada’s labour supply has been squeezed by a combination of an aging work force that is retiring, and a fall in immigration during the COVID-19 pandemic.

Mr. Macklem said that labour supply could improve as immigration normalizes. Immigration is already back to prepandemic levels, and the federal government said last week that it would boost new admissions of permanent residents to an annual target of 500,000 people in the coming years.