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

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

After Tuesday's latest release of inflation data, warnings from Bank of Canada governor Tiff Macklem in his testimony to parliament last week offer a stark reminder of how difficult, but how essential, it is to 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 difficult for consumers, whether businesses buying from other businesses or ordinary Canadian shoppers. Macklem said they simply cannot distinguish reasonable and necessary price rises to cover rising costs from price hikes merely to pad the bottom line.

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

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, obscure the 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 led the post-COVID bout of inflation. Wage hikes have steadily been below inflation. Latest Canadian jobs figures show wage 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 is a special opportunity for sellers. In the confusion of widespread price increases, consumers simply cannot distinguish between reasonable price increases due to a discreet 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 or is this 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 businesses have trouble doing that in normal, non-inflationary times 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.