The central bank is considering two potential solutions to this issue. Workers may agree to spread wage increases over a longer period, or the bank might raise its policy rate to slow down the economy and curb wage gains. If wage growth does not decelerate, the bank might raise its policy rate, especially if underlying inflationary pressures persist.
Rising wages can inflate the economy via demand and supply. Higher wages enhance households’ purchasing power, thus increasing demand and fueling inflationary pressures. However, while consumer expenditures have increased this year, spending per capita is lower, suggesting restrained spending despite income gains. Rapid wage growth without corresponding productivity gains or cost of living adjustments inflates business costs, which are often passed onto consumers through price hikes. This leads to an inflationary supply shock, a primary concern for the Bank of Canada and Deputy Governor Nicolas Vincent.
Changes in pricing behavior have exacerbated these concerns, with firms increasing prices more frequently. The central bank aims to prevent an inflationary loop by urging wage restraint.
However, there’s a risk of overtightening monetary policy. After a 475-basis-point increase in the policy rate, rising insolvencies, and high household indebtedness have led to many households financially struggling. This could result in significant job losses and a potential hard landing for the Canadian economy, posing financial stability risks and possibly leading to a deep recession.
The Bank of Canada now faces a dilemma: should it prioritize returning inflation to its target, risking economic instability, financial stability risks, hard-landing probability, and a deep recession, or adopt a more cautious approach, risking persistent high inflation requiring a more robust intervention later? As of now, economists widely predict the Bank of Canada will maintain interest rates this week, considering current inflation data and the delayed impact of previous hikes.
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Source: Economy - investing.com
