As we near the Bank of Canada final policy rate decision on the year, some economists say we could start seeing inflation decline in the months ahead.

Inflation remained steady in October at 6.9 per cent year-over year, far from the Bank of Canada’s two per cent target. The central bank has delivered six consecutive rate hikes this year, all done with the goal of bringing inflation under control. Its next policy rate decision will take place on Dec. 7. 

Peter Dungan, an economics professor at the University of Toronto’s Rotman School of Management, said in a phone interview on Monday that it is “certainly possible” inflation has peaked. 

The beginning of the year was marked by large increases to the cost of oil and food, which both feed into the consumer price index (CPI), Dungan said. Since the CPI measures current costs against the previous year, Dungan said inflation could abate as food and fuel prices recede. 

“What will be happening is that next March, April [and] May, is the inflation rate is going to come down a lot because then we'll be measuring the year-over-year change against a price level that already has those oil and wheat price increases in it,” Dungan said. 

“So unless those oil and wheat prices keep rising and so far they have not, then what will happen is the inflation rate, which is the change in prices, will be coming down.”

However, Dungan said higher energy and food costs have eroded purchasing power for consumers. Reductions in purchasing power will work to lower inflation, as it will decrease consumer demand, according to Dungan

“And that would have happened whether or not the Bank of Canada had increased interest rates or not,” he said. 

FORWARD GUIDANCE 

A University of Toronto economic forecast on Nov. 7, predicted inflation to fall from 6.8 per cent in 2022 to four per cent in 2023, to 2.2 per cent in 2024 and back to two per cent in 2025. 

“One of the things I am surest about is that within two, three, [or] four years max, our inflation rate one way or another will be back down in the one to three per cent range. There's nothing I see on the horizon that stops that from happening, except world disaster,” said Dungan. 

James Orlando, a senior economist at Toronto-Dominion Bank, said in a Nov. 18 note to investors that he also sees inflation starting to decelerate in the months ahead. 

“Slowing global demand is expected to put further downward pressure on energy prices and rapidly declining shipping costs, the main drivers of high food and fuel inflation over the last year (assuming no new shock) should contribute to lower inflation in the coming months,” Orlando said. 

Since March the central bank has hiked interest rates six consecutive times, in a series of moves that are expected to take years to permeate through the Canadian economy. 

According to the Bank of Canada, it generally takes around 18-24 months to see the full effects of a policy rate change. 

Dungan said each hike delays the effects further. 

“So in a sense, the finishing point of all of the rate hikes is moving further and further into the future as the rate hikes occur,” he said. 

EXPECTATIONS

As the successive rate hikes work through the economy, Dungan said this begs the question if the central bank should wait to see the effects before driving borrowing costs up further. 

“And the prime answer to that is expectation. The big danger with inflation when it happens, even if…a lot of it would go away fairly quickly like within a year or two…is that it gets into people's expectations,” he said. 

If inflationary expectations are allowed to become entrenched, Dungan said this could cause employees to broadly demand pay increases and if wages increase on these assumptions it could lead to a wage-price spiral similar to the 1970s and 1980s. 

“What the [central] bank has really been trying to do has been [to] get people's attention [and] make it clear to people ‘we are not going to validate higher inflation in the future.’ And it's possible they've had to overshoot on interest rates to do it,” he said. 

As such Dungan said that based on the importance of expectations, the central bank may not stop raising interest rates until inflation starts to recede.