(Bloomberg) -- Bank of Canada Governor Tiff Macklem said he remains firmly on an interest-rate hiking path because policy makers are worried about elevated domestic price pressures and inflation expectations becoming entrenched.
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Macklem, in a speech Thursday, painted a picture of an economy that is still "clearly" in excess demand, with businesses facing an extremely tight labor market, wage gains broadening and underlying inflation pressures showing no signs of letting up.
The hawkish comments pour cold water on arguments that the Bank of Canada will diverge much from what's expected to be a more aggressive Federal Reserve.
Canada benchmark two-year yields hit the highest level since 2007 on his comments, rising more than 5 basis points to as high as 3.979%. Traders firmed up their bets on a 50-basis-point rate increase at the next policy decision on Oct. 26.
Before the speech, short-term money markets were betting the Bank of Canada would stop at 4%, about 50 basis points lower than where the Fed is seen heading. Markets are now pricing in 50-50 odds that Canada's terminal rate will hit 4.25%.
Macklem said that while a recent slowdown in the headline annual reading is "welcome news", inflation will "not fade away by itself."
"Simply put, there is more to be done," Macklem said, according to prepared remarks to the Halifax Chamber of Commerce. "The clear implication is that further interest rate increases are warranted."
In an apparent signal the central bank doesn't see itself near the end of its tightening cycle, Macklem said: "We will need additional information before we consider moving to a more finely balanced decision-by-decision approach."
The central bank has already increased borrowing costs by 3 percentage points since March.
"Don't expect the Bank of Canada to shy away from outsized interest rate increases any time soon," Royce Mendes, head of macro strategy at Desjardins Securities, said in a report to investors.
Macklem said there's some evidence global inflationary forces have begun to ease, helping to bring the annual headline rate down to 7% in August. But he downplayed the impact the recent slowdown will have on central bank policy.
The governor said price pressures are increasingly becoming domestic and shifting toward services, and that inflation won't fall without tightening monetary policy.
Officials also can't count on easing global pressure to lower inflation in Canada for three reasons, Macklem said. It will take time for global factors to feed through into the economy, the recent depreciation of the Canadian dollar will fuel the cost of US goods, and there's considerable uncertainty about evolution of supply chains and commodity prices.
Domestic inflationary pressures, meanwhile, are becoming more important, and there's worry expectations could harden at current levels. Wage growth has risen and continues to broaden, Macklem said, and businesses are passing higher input costs onto consumers.
That could create what he called self-fulfilling inflation. "The longer high inflation persists and the more pervasive it becomes, the greater the risk that high inflation becomes entrenched," Macklem said.
The central banker reiterated his commitment to the Bank of Canada's 2% inflation target, and urged Canadians to make wage and price decisions based on the assumption it will succeed.
"We know we are still a long way from the 2% target. We know it will take some time to get there," he said. "We also know there could be setbacks along the way, and we can't afford to let high inflation become entrenched."
Survey results of consumer and business expectations due later this month will be important for the bank's assessment of how expectations have evolved, he said.
(Updates with analyst comment)
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