Bank of Canada says trade disruptions could hinder inflation fight

By Promit Mukherjee and David Ljunggren

OTTAWA (Reuters) - Global trade disruptions could make it harder for the Bank of Canada to consistently meet its 2% inflation target, and it will have to balance the risks of controlling higher prices with ensuring economic growth, Governor Tiff Macklem said on Tuesday.

Inflation has fallen this year, pushed down by interest rates that were at a two-decade high of 5% for more than a year before the bank cut rates three times in a row from June.

Macklem said with globalization slowing, the cost of global goods might not decline to the same degree and this could put more upward pressure on inflation.

"Trade disruptions may also increase the variability of inflation," he said in a speech to the Canada-UK Chamber of Commerce in London, citing the effect that supply shocks can have on prices.

Global trade is being disrupted as more countries, especially in the advanced world move towards export of services from goods, and as geopolitical tensions, especially due to China's trade policies, shift supply chains.

"Trade disruptions may mean larger deviations of inflation from the 2% target," he said.

This means the bank is focusing on risk management to balance inflation and growth and investing to better understand global supply chains, he said.

Overall inflation in Canada in July fell to a 40-month low of 2.5%.

Canada is a small, open economy which relies heavily on trade and is therefore particularly vulnerable to disruptions.

Supply shocks such as the one seen during the pandemic are creating a difficult trade-off for central banks since monetary policy cannot stabilize growth and inflation at the same time, Macklem said.

"We're updating our models to use scenarios when periods of uncertainty make central forecasts less reliable," said Macklem, adding that the bank was using more micro-data to track and understand the consequences of trade and industrial policy.

The Bank of Canada has to ensure inflation is "low, stable and predictable even as global trade is being rewired, recast and redirected", he said.

Canada last month imposed a 100% import duty on Chinese-made electric vehicles and on Tuesday launched consultations on whether to slap a surtax on Chinese critical mineral products, batteries and parts, solar products, and semiconductors.

"Canada is not going to be the cheapest alternative," Macklem said, but it had a highly skilled labor force, reliable energy and transportation networks and solid financial institutions which could be its strengths.

($1 = 1.3612 Canadian dollars)

(Reporting by Promit Mukherjee and David Ljunggren in Ottawa; editing by Jonathan Oatis)