Global trade disruptions could make it difficult for the Bank of Canada to consistently hit its 2% inflation target, and it will have to balance the risk of controlling higher prices with ensuring economic growth, Governor Tiff Macklem said on Tuesday.
Inflation in Canada has declined consistently this year, driven by interest rates that stood at a two-decade high of 5% for more than a year before the central bank cut rates three times in a row starting in June.
Macklem said, with globalization slowing down, the cost of global goods may not fall at the same rate, and this could put greater pressure on inflation.
"Trade disruptions may also increase the impact on inflation," he said in a speech to the Canada-UK Chamber of Commerce in London, referring to the impact of supply shocks on prices.
"Trade disruptions are likely to cause a larger deviation of inflation from the 2% target."
This means banks are focusing on risk management to offset inflation and growth and investing to better understand global supply chains, he said.
Overall, inflation in Canada in July fell to a 40-month low of 2.5%.
Canada is a small, open economy that relies heavily on trade, making it vulnerable to disruption.
Supply shocks like those seen during the pandemic create a difficult dilemma for central banks because monetary policy cannot stabilize growth and inflation at the same time, Macklem said.
"We are updating our models to use scenarios when periods of uncertainty make key forecasts less reliable," Macklem said, adding that banks are using more micro data to track and understand the impact of trade and industry policies.
Canada needs to prepare for trade disruptions that seem inevitable amid a changing trade landscape, he said. It needs to keep inflation "low, stable and predictable even as global trade is being changed, reshaped, and shifted."
He said that while the BoC does not set trade policy, it needs to understand changes in global trade as they affect Canadians and affect costs and inflation.
The BoC in June became the first G7 central bank to start cutting borrowing costs as inflation continued to remain within its target range of 1-3% this year. The bank has cut its key policy rate by 75 basis points to 4.25% this year.
