Heather Scoffield is Senior Vice President, Research, Canadian Policy, at the Conference Board of Canada.
Canadians and economists spent 2018 poring over data to find out where we were at in the fourth quarter. And while we learned that this recent and pronounced uptick in the consumer price index is a strong indicator of the broader labour market, the rest of the GDP numbers were lower-than-expected. This led to a series of downgrades in future forecasts.
These issues are all important, but I worry the headlines this week focused too much on the implications of a sudden increase in inflation rather than a particularly strong economy. The second component of the Bank of Canada’s inflation target, as set out in the inflation target agreement, is the “period of maximum employment.” That means our central bank must hold the inflation rate around the 2 per cent target to keep employment to its full potential.
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With labour market slack now disappearing, we are seeing a significant strengthening in the two other components of the target: prices and the neutral rate of interest. Both are at historic levels. The pace of inflation is likely to fade somewhat as we move through 2019. The pace of job creation will be much more important for shaping the outlook for rates in 2019 and beyond.
It’s also important to remember that monetary policy does not affect inflation in isolation. In recent years, Alberta has relied largely on population growth to reduce unemployment. As some of that growth is slowing, the ability of the provinces to keep some of the job gains will shrink further. All of these factors will work in different ways to move the inflation rate.
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On the other hand, Canadian consumers, whose spending makes up about 60 per cent of economic activity, have benefited from a strong economy. And, once the run-up in fuel costs has become less pronounced, they should continue to see more of a dollar for their buck than when they did so last year.
Back in 2015, Canada’s fastest-growing area of employment was service providers. These include doctors, accountants, cleaners, cafeteria staff, sales agents, care workers, landscapers, and more. Perhaps the unemployment rate figures released on Friday are a counter-narrative to the headline inflation numbers.
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Regardless, their corner of the economy, which is now adding workers faster than the rest of the country, is growing so much faster than the rest of the country that I worry it will make the next move on interest rates premature. This is because we could get in a position where the Bank of Canada needs to be looser later this year than we might like. One way or another, we are going to have an early reminder of the balance this balance, or the need to keep a lid on expectations, lies at the heart of our economic policy challenges.