Canada may need a recession to combat inflation

Economists report inflation in Canada to peak in the fourth quarter of 2022, as there are signs of rapid price increases, confirming the need for a recession in order to avoid the wage-price spiral. 

The inflation data for August are expected to be released on September 20. Thus, the overall price level for goods and services is projected to fall to 7.3%, despite July's reading of 7.6%.

Three main measures of core inflation, however, would be considered, including CPI Common, CPI Median, and CPI Trim. Combined, these indicators showed a rise of 5.3% in July. 

Six of the eight economists polled by Reuters share the view of core inflation to peak in the fourth quarter as national and global pressures begin to ease. At the same time, it is becoming clear that a return to the 2% target won’t be brisk.

As economists mentioned, increasing prices, higher wages, along with rising inflation expectations from both consumers and organizations, are all signs of entrenched inflation. 

The Central Bank of Canada has sought to avoid these aftereffects by tightening monetary policy, in particular through a series of interest rate hikes. But such measures to combat high inflation proved to be insufficiently effective. 

Over the past 6 months the country's bank has already surged the rate by 300 basis points, now reaching 3.25%. That is considered a 14-year maximum, being also the highest interest rate among other central banks that control the 10 most traded currencies.

Nevertheless, experts believe the shift to a rising wage trend leading to higher prices, known as a spiral, won’t be permanent, particularly in case of economy’s slowdown. 

"We believe monetary tightening will be followed by a recession next year. Thus, consumer and institutional expectations are unlikely to be fully met," said Nathan Janzen, associate chief economist at Royal Bank of Canada (RBC).

Economists at Desjardins Group and Oxford Economics also mention sharp rate hikes, leading to a recession, but refer to it as a mild downturn. 

The Bank of Canada, in turn, claims it has the power to slow GDP growth without harming the economy.

"In fact, the central bank remains committed to cooling the economy as it plans to return inflation to its target," said Carolyn Rogers, senior deputy governor of the Bank of Canada.

As for core inflation, a return to the 2% objective is slated for 2024. Most economists agree with this timeline, although there is a possibility that it could be achieved sooner.