Bank of Canada worried about impact of oil shock on inflation during rate deliberations
The Bank of Canada debated the impact soaring oil prices stemming from the war in Iran could have on inflation ahead of their most recent interest rate decision, with some governors concerned that a near-term increase would raise inflation risks over a longer period.
A summary of deliberations by the central bank’s governing council, which led to the key overnight interest rate being held at 2.25 per cent on March 18, shows that was among the concerns expressed in a discussion about the importance of different risks to the inflation outlook.
“Higher gasoline prices, combined with still-elevated inflation in essentials such as groceries, could push up inflation expectations,” the summary said. “This was particularly relevant given that the experience with high inflation in 2022–23 remained fresh in people’s minds.”
However, while the persistent post-pandemic inflation spike informed the discussions, another perspective was that the impact of higher energy prices on ongoing inflation could be more limited. For one thing, the economy is starting from a position of excess supply and inflation is around the central bank’s target of between one and three per cent.
The central bankers discussed how this could limit the pass-through of energy costs to other goods and services.
Moreover, while higher inflation expectations typically make it easier for businesses to pass along cost increases, firms often look for ways to avoid raising prices when the economy is soft so they don’t lose customers, the summary said.
“Similarly, upward pressure on wages is less likely in a weak economy,” the summary said.
In the end, the governing council concluded that while risks to growth looked tilted to the downside, and the oil price shock added additional upside risk to inflation, it was too early to tell how these risks would evolve. So the decision was made to hold the overnight rate steady.
The statement of deliberations said central bankers will have to rely on judgment “more heavily than usual” as they assesses data to determine whether to raise, lower or hold interest rates against a backdrop of soaring oil prices and the potential for rising inflation stemming from the ongoing Middle East conflict.
For now, they concluded that they could look through the immediate effects from the oil shock on inflation and be prepared to act in the future, if needed, to ensure that price increases did not spread to other goods and services and become persistent inflation.
“(The governing council) agreed that they had some flexibility because inflation was close to target and core measures suggested limited pressures,” the summary said.
“They could therefore take some time to see how the war in Iran evolved and what it meant for the outlook.”
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