Unless the pace of rising wages slows or productivity increases, labour costs could add to inflationary pressure, reducing the prospect of a soft landing for the economy, says a new report from Scotia Economics.
While labour costs haven’t had much impact on inflation so far, they’re an important factor in future inflation scenarios, it said.
Scotia’s base forecast calls for the economy to slow in the months ahead, which should lead to slower wage growth as consumer demand eases and tight labour markets soften.
“However, if wage growth does not slow down and continues at its current speed, it could add additional pressure on inflation through higher production costs, forcing the hand of the central bank,” the report said.
In an alternate scenario, where workers lose confidence in the Bank of Canada’s ability to curb inflation — elevating their wage demands and keeping wage growth high — the economy would have to take a harder hit to bring inflation under control, it said.
“Our model shows that more persistent wage pressure combined with reduced central bank credibility could lead to a larger decline in real growth for the central bank to bring inflation back to its target, reducing the possibility of a soft landing,” it said.
One way the economy could accommodate higher wage growth without higher inflation would be through improved labour productivity, the report said.
“While wage growth is increasingly a concern, the likelihood of lower productivity growth could be a greater threat to economic growth and inflation,” it said.
“If wage growth persistently exceeds productivity growth, firms face higher labour costs per unit produced and may raise prices to preserve profitability, potentially reinforcing inflationary pressures especially in labour-intensive sectors,” it added.