The Cost Of Controlling Inflation

THE COST OF CONTROLLING INFLATION

CIBC managing director and deputy chief economist Benjamin Tal’s views on the potential impact of inflation and rising interest rates on the housing market

BY CARLA GILES

Inflation is likely to be brought back to within the Bank of Canada’s target range of 1 to 3 per cent in a couple of years, but the cost of getting there could be high if the Bank’s actions in the interim trigger a recession, CIBC managing director and deputy chief economist Benjamin Tal told a recent Industry Forecast event organized by CMBA-BC.

While many Canadians are concerned about the impact of rising inflation, Tal worries that the Bank of Canada may trigger a recession by overshooting and raising the policy interest rate beyond 3 or 3.5 per cent. He notes the Bank monitors inflation expectations and will act accordingly until it is convinced that the public believes inflation is not out of control and will be brought down.

Tal said several forces are contributing to current inflation levels, with some being less sensitive to a rise in the policy interest rate. For example, he said the global supply chain disruptions experienced through the pandemic are inflationary but should ease as consumers shift their demand for goods to services as part of the transition from a pandemic to an endemic with less restrictions. The shift from goods to services will be deflationary as services are less sensitive to supply chain disruptions, he added.

Tal said energy was another inflationary force partly due to the current “energy shock” marked by significant European efforts to reduce dependence on fossil fuels. However, he believes oil prices are less inflationary today than in the past because there is less sensitivity to oil price hikes due to gains in energy efficiency.

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interest rates

On the housing front, Tal said rent inflation is expected to accelerate in coming years as demand continues to increase and supply shortage becomes more pronounced. He added that homebuyers who could afford to buy a property during the pandemic benefited from a recession without the cost of a recession.

Also, during the pandemic, unemployment rose most significantly for low-wage earners who were most often renters. However, with the ease of restrictions there is a shortage of workers for low-paying jobs leading to wage inflation becoming more pronounced in this sector. Tal said this could be a result of changes in the labour market structure due to increased flexibility to work remotely.

Most new immigrants (about 70 per cent) are already in Canada as students who can speak the language and are

more employable, which could have led to fewer low-paying jobs being filled by new immigrants.

Tal expects the housing market to soften and experience a price correction through 2023. He said this would not be a bad development because a price correction would rebalance the market and avoid prices rising as quickly as they did over the past two years.

Tal added: “If the Bank of Canada stops the rise of the policy interest rate at 2.5 or 2.75 per cent, I think we will be fine. If we go to 3.5 per cent too quickly, that’s when an adjustment in the market will be more significant.”

He said that while the strong demand for housing should ensure prices rising again within a couple of years, there will be a more accentuated shortage of supply triggered by increasing construction costs.

“The ultimate measure of intelligence is what to do when you don’t know what to do. Nobody knows exactly what will happen.”

“Construction costs are rising faster than prices, so developers’ margins are shrinking,” he said, adding that builders are choosing to defer or even cancel projects as they face record-high job vacancies and a shortage of building materials.

In the short and medium term, Tal said he hopes the easing of the housing market and the expectation that supply chain issues will diminish by October or November this year may be sufficient to convince the Bank of Canada that there is no reason to overshoot by raising the policy interest rate beyond 2.5 or 2.75 per cent.

He is also hopeful this will be sufficient to keep inflation expectations in check while allowing supply chain issues to dissipate slowly. However, if 2022 does not materialize as a transition year and the pandemic gets out of control, all bets are off.

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