Bank of Canada might need to raise rates if companies keep raising prices, Macklem warns

It may soundlike a circular argument, but the only way to stop inflation is to stop companies fromraising prices. And the only way to stop thatis to get inflation under control. And that could mean an end to the interest rate hike pause.

After Tuesday'slatestrelease of inflation data,warnings from Bank of Canada governor Tiff Macklemin his testimony to parliament last week offer a stark reminder of how difficult, but how essential, it isto convince the sellers of goods and services to stop raising prices.

While overall inflation has eased to 5.9 per cent, that's still high. Groceries are up another 11.4 per cent.

That's difficultforconsumers, whether businesses buying from other businesses or ordinary Canadian shoppers.Macklem said they simply cannot distinguish reasonable and necessary pricerises to cover rising costs from price hikes merely to pad the bottom line.

He warnssellers:if price hikes continue at the pace we've seen recently,he may be forced to take action.

Hidden in plain sight

The latest slowdown in rising prices, finally falling below six per cent for the first time since February a year ago, is being read by many as a favourable sign.

Though it's useful to view that number in context: that's 5.9 per cent higher than a year ago when prices were already rising quickly, or what economists call the "base-year effect."

A fall in global oil prices, which last week Macklem described as the "biggest contributor" to falling inflation, obscurethe rising cost of other consumer necessities, like food.

As people as diverse as Federal Reserve chair Jerome Powell and Canadian labour economist Jim Stanford have noted,despite continued talk of a wage-price spiral, wages have not ledthe post-COVID bout of inflation. Wage hikes have steadily been below inflation. LatestCanadian jobs figures showwage hikes are declining, currently running at 4.5 per cent, more than a full percentage point below rising prices.

"It looks more like profit-price inflation to me where companies very opportunistically have taken advantage of a disruptive moment to soak consumers for more than they need to," was Stanford's analysis in an interview with the CBC last year.

And in last Thursday's testimony to the Parliamentary Finance Committee, Macklem seemed to agree.

Macklem explained that a period of generally rising prices isa special opportunity for sellers. In the confusion of widespreadprice increases, consumers simply cannot distinguish between reasonable price increases due to a discrete cause a frost in Florida that raises orange prices, for example and price hikes meant to squeeze the customer and increase profits.

"When an economy is overheated, when inflation is high, when people see prices of everything going up, it makes it easier for companies to raise their prices because people can't tell, is this ... a generalized increase oristhis just this company raising their prices?" testified Macklem last week.

In economics, the general principle is that sellers want to raise their prices as much as possible to maximize their profits. One of the reasons businesseshave trouble doing that in normal, non-inflationarytimes is that consumers keep an eagle eye on price hikes and shun sellers they think are being greedy. But during periods of high inflation, unjustified individual price hikes are harder to distinguish and therefore retailers are harder to punish.

WATCH |What's causing inflation to slow:

Chicken prices soar as inflation cools

1 year ago

Duration 1:45

Inflation in Canada is down to 5.9 per cent, but food prices are still high with chicken becoming a big-ticket item on the grocery bill.

"When the economy is better balanced between supply and demand, the competitive functionworks much better and it's a lot more difficult for companies to raise prices because they'll lose market share," said Macklem.

"They'll losetheir customers."

Bigger, more frequent price hikes

This round of inflation had real causes: when supplychains suddenly gummed up and oil prices soared,many sellers were forced to raise theirprices. Higher fuel costs and a shortage of cargo vessels meant goods cost more to ship. High worldwide demand for goods in short supply pushed input prices higher.

Essentially everyone who could was just doing their best to passon their higher costs causing an unfamiliar flurry of pricing activity that had not been seen in decades, Bank of Canada research showed.

"The distribution of price-setting behaviour of companies changed," Macklem told the parliamentary committee members. "Pricing increases were bigger, they were more frequent."

But as supply chains opened up those price hikes should have begun to cool down.

The debate over whether grocery retailers in particular have raised prices too much continues to rage and may be revisited later this week when food retailer Loblawsunveils its corporate results onThursday. The company, likeother grocery chains, insists its price rises reflect increased costs.

Critics have pointedto soaring profits.

It may be that shareholders will rejoice if they see profits continue to rise at the expense of consumer prices but if the pace and size of price hikes don't go back to the way they used to be,to "normalize" in Bank of Canada language,Macklemsays he has a surprise up his sleeve.

There are many sceptics who say inflation has no intention of going peacefully and that it will be "sticky." The last time rising prices got seriously out of hand, "The Great Inflation,"only ended in the 1980s after a brutalinterest-rate shock that saw mortgage rates approach 20 per cent. Thatended inflation with a bang anda devastating recession.

So far central bankers seem confidentthat won't happen this time. But if businesses don't get pricing under control soon, Macklem said he will have to do something about it.

"That process of normalization is one of the key things we're watching to evaluate whetherwe raised interest rates enough to get inflation back down to target," testified Macklem.

"And if we don't see it continue to normalize, we will need to do more."