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Governor Tiff Macklem explains that higher interest rates are working to slow inflation but warns that getting all the way back to the 2% target may take time. He also discusses the recent stress in the global banking sector and how financial stability and price stability work together.

Watch Governor Macklem speak to the Toronto Region Board of Trade. Read the full speech.

Restoring price stability will take time

Inflation fell from its peak of 8.1% last year to 4.3% in March. We expect it will decline to around 3% this summer. This is good news and shows that interest rate increases are working to rebalance the economy. But the work of monetary policy is not done.

Low, stable and predictable inflation is key to Canada’s economic well-being, which is why inflation must be centred on the 2% target.

Getting all the way there will take time and involves risks, notably that services price inflation could stay higher for longer than we expect. For services price growth to slow enough for inflation to get back to target, three things need to happen:

  • The labour market needs to rebalance, and wage growth needs to moderate.
  • Businesses need to slow the pace and size of their price increases.
  • Inflation expectations need to come down—too many people still believe inflation will be higher than our forecasts over the next two years.

We’re on track, but there is a risk it might take more time than expected for these three things to occur. If that happens, inflation could get stuck above our 2% target.

I’m not here to talk to you about the journey from 8% to 4% or even 3%. I’m here to talk about staying the course to price stability and getting the rest of the way back to the 2% target. Monetary policy still has work to do.”

Why do we target inflation? Check out our explainer on inflation targeting.

The path from 3% to 2% is less certain

The adjustment to higher interest rates has not been easy, but the alternative—lasting high inflation—is worse. Low, stable inflation at our 2% target allows Canadian households and businesses to budget, save and invest with confidence.

We have held interest rates steady since January as we assess whether interest rates are high enough to return inflation to target. We expect inflation to fall quickly this summer, but the path from 3% to 2% is both slower and more uncertain. If we start to see signs that inflation is likely to get stuck above target, we are prepared to raise interest rates again.

Financial stability affects price stability

Recent stresses in the global banking sector haven’t really had an impact here in Canada. But more severe stress could trigger a global recession, which would affect Canada—particularly given our high level of household debt.

Financial stress leads to tighter financial conditions. This essentially means it becomes harder and more expensive to get loans. Raising the interest rate does this too. By raising our policy rate from 0.25% to 4.5%, we are:

  • slowing the flow of credit
  • lowering the demand for goods and services so supply can catch up

That’s why we’re watching risks to financial stability closely. They could affect our path to 2% inflation, so we need to consider them when we conduct monetary policy.

If financial stress were to lead to more tightening than expected and if this were to persist, we would need to take this into consideration as we set the policy rate to achieve our inflation target.”

Watch Governor Macklem answer questions from the media after his speech.

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