With global trade increasingly stoking inflation, rather than easing it, the Bank of Canada may have to keep interest rates higher for longer to bring price pressures to heel, says TD Economics.
In a new report, the bank’s economists said globalization has long served as a disinflationary force, but this trend began waning with the global financial crisis.
In recent years, geopolitical tensions like trade disagreements between the U.S. and China, the pandemic, and the Russian invasion of Ukraine combined to disrupt global supply chains and revive demand for increasingly-local, but costlier, production.
“With this structural shift likely to have staying power, one important implication is that central banks will no longer be able to count on goods price disinflation over the long haul. This, in turn, underscores the likelihood that the equilibrium nominal interest rate is likely to remain higher in Canada and globally than in the past,” it said.
In the short term, slowing demand and the easing of global supply-chain disruptions should curb inflationary pressures — but longer-term “costly investment” will be needed to “reshore” production and to fund the green transition, it noted.
“The shift in global production has many implications. There is the potential for a desynchronization in regional economic growth, hit to innovation, and reduced economies of scale and competitiveness. But one thing naturally follows and that is the potential for higher inflation,” TD said.
“This will be on the radar of the Bank of Canada. Given its 2% inflation target, the removal of a deflationary force implies that nominal interest rates will stay higher over the long haul than otherwise would have been the case,” it concluded.