Macklem plays down wage-and-spending surge but promises faster hikes if inflation spikes

That increase in mortgage rates that everyone has been warning you about may be coming faster than you thought. Depending on who you listen to, it may be a lot faster.

Yesterday's decision by the Bank of Canada to stop stimulating the economy with bond buying is already havinga small effect on lending rates, said people who watchthe mortgage market.

But perhaps evenmore important is the fact that the Governor of the Bank of Canada Tiff Macklemhas dramatically changed his message from one of relative complacency that inflation would look after itself to one where the central bank has committed itself to actively drive inflation down with cuts to stimulus.

Threading a careful path

The strategy is a tricky one, because Macklemwants to thread a careful path between scaring business investorsand home buyers with threats of high interest rates that could discourage new investment while taking a hard enough line toconvinceeveryone that the central bank will not let inflation persist in the economy.

Many bank economists, including Scotiabank's Derek Holt and the Bank of Montreal's Doug Porter seem skeptical that Macklemcan have it both ways, suggesting that consumer spending and wage demands maypush inflation, and the interest ratehikes needed to fight it,up faster than the Bank of Canadais willing to project in its latest Monetary Policy Report (MPR).

Both economists remarked on Macklem'ssuddenchange in tone.As well as abruptly ending the stimulating effect of quantitative easing the purchase of bonds in the market to make borrowing evencheaper and easier for those who could afford to borrowthe central bank has announced it will begin raising interest rates in the middle of next year.

The Bank of Canada expects consumer spending to be the major economic driver as the economy reopens. Its governorexpects supply problems will help push prices higher, contributing to inflation.

But while Macklem expects people with pandemic savings will only spend 20 per cent of that cash on goods, others, includingthe boss of RBC, David McKay,have predictedconsumers will go on a major spending spree, driving inflationto new heights. It's possible that rising inflation would actually encourage spending as people watch the value of their savings shrink.

In any case, retailbank economists seem to widely agree that both inflation and ratesrises will be sooner, more frequent and ultimately higher.

Earlier, faster and higher

"Clearly, the risks are tilted to an even earlier move, and yes the possibility of a faster cadence, and a higher end point," wrote BMO's Porter in a release shortly after the central bankput out its OctoberMPR.

Although he said they would not likely be needed, Macklem conceded the bank could move faster on rates.In response to a direct question about whether the central bank would continue to push rates higher if inflation persisted, Macklem gavea tough, if slightly confusing confirmation in central-bank-speak.

"If there are new developments that are pushing inflation away from our target for longer, I think, yes, you can absolutely expect that we will be continuing to adjust our policy settings toensure that we willget inflationback to target," said Macklem.

What did you expect?

What Macklem seemed worried about were inflationary expectations, the idea that if we are all certain that inflation is on the way up, workers will demand higher wages and businesses will raise their prices, effectively making inflation rise. Some say that process has already begunas global supply bottlenecks push prices higher and labour shortages increase wage demands.

Certainly Macklem seemed to play down the effect of wage demands, saying there were few signs yet of pay increases contributing to inflation. But as Scotiabank'sHolt noted, with the Bank of Canada projecting inflation will rise to fiveper cent this year, wages will also be under pressure to increase.

"I think we are starting to see some massive evidence of wage pressures that could reinforce some of this inflationary trend as we go into the next year," said Holt in an interview. He said rate hikes could begin as soon as January.

If he is trying to reach wage earners, Macklem's repeated insistence yesterday that inflation will not rise much and will soon come back down may be falling on deaf ears. Workers who pay little attention to statements by central bankers are much more attentive torising prices that mean their pay doesn't go as far.

As Finance Minister Chrystia Freeland noted Wednesday in a question and answer session with the Canadian Chamber of Commerce, during election campaign door-knockingthe key thing she found that Canadians demand of their governments and their employers is an adequate standard of living.

"If there's a job and I take that job, can I have a decent life for me and my family?" said Freeland.

As the price of everything from food to houses rises by five per cent, it may be hard to make the political case that wage earners should pay for it with a lower standard of living while everyone else gets an increase.

Follow Don Pittis on Twitter @don_pittis