Deputy Governor Toni Gravelle talks about the Bank of Canada’s decision yesterday to leave the policy rate unchanged. He explains the link between supply bottlenecks and high inflation and why the Bank thinks both will ease over time.

Watch Deputy Governor Gravelle speak to the Surrey Board of Trade by webcast. Read the full speech.

Our decision yesterday

We decided to maintain the policy interest rate at 0.25 percent. We also decided to maintain our commitment to hold the policy rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved.

The unique recovery has disrupted supply chains

Canada’s economy has made great progress since the pandemic began, thanks to high vaccination rates and a broad reopening. But this recovery is a highly unusual one, and a lot of uncertainty remains.

Among the key risks to the Bank’s outlook are the supply disruptions that we’ve all experienced lately. This is a global phenomenon that is also affecting Canada. Wait times are longer for everything from cars to building supplies, and some goods aren’t available at all.

Much of the disruption comes down to the fact that, throughout the pandemic, households in many countries have had less opportunity to spend on services like restaurants, live concerts or travel, so they’ve spent mainly on goods instead.

Many of the goods we buy—and parts that go into them—come from abroad, so this shift has put a great deal of pressure on supply chains.

Factors that have intensified the bottlenecks and delays include:

• businesses stocking up on inputs in a bid to avoid delays for their products
• bad weather and natural disasters such as the floods in British Columbia
• labour shortages, in part because as the global economy recovers from the pandemic, matching workers with jobs is taking time

Supply constraints have led to higher inflation

Inflation as measured by the consumer price index (CPI) has been higher than the Bank’s 2 percent target in recent months. This is because strong demand combined with disruptions in supply have led to higher costs for businesses and higher prices for consumers.

Supply constraints have increased the prices of many CPI components—most of them tied to goods.

The average inflation rate of goods in 2021 has been 4.4 percent—much higher than that of services, which has been 2.1 percent. In the 20 years before the pandemic, goods inflation averaged only 1.4 percent.

Supply issues remain a risk but will ease over time

As businesses and consumers adjust to the imbalances of supply and demand, supply disruptions and their effect on prices should ease. But it will be a complex process that takes a while.

Some firms will boost their capacity to meet demand by expanding factories, investing in new technology and hiring workers. Others may tweak their products to get around shortages and cut costs.

Consumers have already started spending more of their income on hard-to-distance services again. They may also shift their purchases away from goods that are in short supply.

Although we’re seeing early signs of adjustment, there is a risk that these disruptions could last longer than expected.

Our view remains that inflation will stay high during the first half of 2022 and ease back towards 2 percent in the second half of the year. However, we’ll be watching inflation expectations and labour costs closely to ensure that the forces pushing up prices don’t become embedded in ongoing inflation.

Watch Deputy Governor Gravelle answer questions from the media following his speech.