Signs of a robust recovery in the final quarter of 2021, along with indications companies are planning price increases, point to an earlier hike in policy rates from the Bank of Canada and the US Federal Reserves than expected, says Scotiabank’s chief economist.

“Major revisions to our United States and Canadian policy rate profiles are in order,” Jean-François Perrault, Senior Vice-President and Chief Economist at Scotiabank, noted in a Scotiabank Economics forecast on inflation and interest rates.  

In Canada, incoming data, including strong employment numbers, point to a strong expansion in the fourth quarter. On top of that, there is increasing evidence of an acceleration in wages and ensuing price increases. The Canadian Federation of Independent Business (CFIB)’s business barometer suggests businesses expect prices to rise 4.3% in the next year, a pace that is nearly 2.5 times more rapid than the average expectation over history.

“As a result, we have raised our inflation forecast for the next two years, with core inflation, defined as the average of the BoC’s three preferred inflation measures, averaging 3% in 2022 and falling slightly to 2.7% in 2023,” Perrault said. 

The data suggests the Bank of Canada (BoC) will need to tighten earlier than July, as the Bank’s economists had previously predicted, noted Perrault in his report.

“We now believe the Bank of Canada will raise rates in April, followed by three consecutive 25-basis-point moves in following meetings,” he said. “We remain of the view that 100 bps of tightening is forthcoming in 2022, followed by another 100 bps in 2023. The real policy rate would remain negative through the end of 2023.”

In the United States, the Fed appears to be paving the way for higher policy rates on concerns about inflation. As a result, Scotiabank now expects rate increases by mid-2022, instead of late-2022, with 100 basis points (bps) of tightening expected in the year. As in Canada, growth remains robust, but inflation is much higher, though much of that can be accounted for by the inclusion of used-auto prices in US inflation measures. Another factor in the Fed’s rate decision is that the US labour force participation rate, which in Canada now exceeds pre-pandemic levels, remains well below that in the US.

The Canadian outlook accounts for a recovery in 2022 of any lost activity from the floods and landslides that crippled the interior of British Columbia and continue to disrupt transportation to and from the Port of Vancouver. At best estimate, Perrault said, the floods likely reduced annualized growth by about 2%, leaving the quarter at around 3.5%, but he expects real GDP growth to be in the 5% range in the first half of 2022, roughly closing the output gap along the time frame suggested by the BoC.

The report also leaves room for a small negative impact from the Omicron variant. While it seems less harmful than Delta, Perrault noted that Omicron’s high transmissibility is likely to lead to a surge in cases during the holiday season, with the possibility of stronger public health measures early in 2022.

“We will reassess our rate call early in the year when there is more clarity on the implications of Omicron, a better sense of year-end growth dynamics, and labour market outcomes,” Perrault said.

Read the Scotiabank Economics forecast on inflation and interest rates here.