Bank of Canada keeps 2% inflation target, says interest rates may stay low longer

December 13, 2021

By David Ljunggren and Steve Scherer

OTTAWA (Reuters) -The Bank of Canada on Monday unveiled an agreement with the federal government to keep its inflation target unchanged at 2% and said it could maintain interest rates lower for longer if needed to help keep employment at optimal levels.

The decision was set out in a new five-year monetary policy framework between the central bank and the finance ministry that takes effect on Jan. 1. The inflation target has been set at the 2% midpoint of a 1%-3% control range for the last 30 years.

“The primary objective of monetary policy is to maintain low, stable inflation over time,” said the central bank, which along with the ministry decided against a major shift in monetary policy strategy similar to the one adopted by the Federal Reserve last year.

The Canadian central bank said major forces, such as demographics and technological change, were having profound effects on the labor market and making it harder to judge maximum sustainable employment – the level beyond which inflationary pressures arise.

It said it would use the flexibility of the 1-3% target range to seek maximum sustainable employment when conditions warranted and also deal with structurally low rates, “including sometimes holding its policy interest at a low level for longer than usual.”

The bank, however, acknowledged that maximum sustainable employment is not directly measurable and is determined largely by non-monetary factors that can change through time.

The Bank of Canada slashed its key interest rate to a record low of 0.25% last year and says it could start hiking it as soon as next April as the economy recovers from the COVID-19 pandemic. Annual inflation hit an 18-year high of 4.7% in October.

The central bank has taken a flexible approach, allowing the labor market and the economy to rebound while supply-chain bottlenecks and rising energy prices pushed up overall costs.

It said neutral interest rates were likely to be lower than in the past, which meant central banks would have less room to cut rates when faced with major economic shocks.

(Additional reporting by Fergal Smith in TorontoEditing by Matthew Lewis and Paul Simao)

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