In the 1980s and early 1990s, Canada had a serious inflation problem. The inflation rate hit double digits in the 1980s, but under Governor John Crow’s leadership, the Bank of Canada succeeded in bringing it down to below 2 per cent by 1992.
An enduring lesson from that period is that when inflation is not addressed promptly, it can become entrenched — a lesson we had to relearn in the aftermath of the pandemic. Initial supply shocks pushed inflation higher, and what many hoped were transitory pressures turned out to be far more persistent.
Now, fresh risks are emerging. The escalation of hostilities in the Middle East over the weekend could lead to further global supply shocks. Even before these developments, the Federal Reserve was already grappling with rising short-term inflation expectations and trying to determine whether they represent a temporary blip or a more lasting trend.
Compounding these pressures, tariffs are driving up the cost of goods, and now the risk of oil supply disruptions could push energy prices even higher, further complicating the inflation outlook.
During the early stages of the pandemic-related supply chain disruption, the Fed maintained an accommodative monetary policy stance — a move that ultimately allowed inflation to take hold. Central bankers are keen to avoid repeating such policy missteps, which is a key reason the Fed has kept rates on hold despite the current policy rate remaining modestly restrictive.
Central banks understand that anchoring inflation expectations is crucial. For monetary policy to be effective, the public must have confidence that in the long-term, monetary authorities will act to return prices to their normal levels. If not, inflation expectations will become unanchored, causing distortions in prices and consumer behavior.
The escalating conflict in the Middle East is adding to policy uncertainty. In response to the recent US strikes on its nuclear sites, Iran’s parliament has voted to shut down the strategically vital Strait of Hormuz, prompting fears of a sharp spike in oil prices that could trigger a global recession. The decision to close this critical shipping channel now rests with Iran’s Supreme National Security Council.
Roughly 20 per cent of the world’s oil supply flows through the Strait of Hormuz, which is a gateway out of the Persian Gulf and one of the most critical oil transit chokepoints globally. As of Friday, Brent crude was selling at around $77 per barrel — up more than 10 per cent since mid-June, when Israeli strikes on Iranian nuclear sites triggered retaliatory attacks from Tehran on Tel Aviv.
Some analysts have downplayed the risk of long-term disruption to shipping routes, pointing out that most of Iran’s oil exports to China also rely on passage through the Strait of Hormuz. However, in a recent note, Goldman Sachs outlined several scenarios for the potential impact of a closure. In its high-end estimate, Brent crude could briefly spike to $110 per barrel if oil flows through the critical waterway were cut in half for a month and remained down by 10 per cent for the following 11 months.
The competing view is that closing the Strait of Hormuz could be self-defeating for Iran. Such a move risks turning its oil-producing neighbors — many of whom have remained neutral or even sympathetic as Iran faced Israeli and US attacks — into enemies. It could also provoke backlash from its key crude oil market, China. The US Energy Information Administration (EIA) estimates that 84 per cent of the crude oil and 83 per cent of the liquefied natural gas that moved through the Strait of Hormuz last year went to Asian markets.
While we can hope for a de-escalation of tensions, this uncertainty will lead to a more cautious approach by the Fed and the Bank of Canada. Mortgage lenders and borrowers should pay close attention to central bank commentary, particularly around inflation expectations, as it will play a key role in shaping future interest rate decisions.
Housing Affordability Watch
CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
The federal GST rebate for new homes hasn’t been updated in decades, leaving most buyers shut out as average home prices soar past $700,000 — well past the phase-out threshold.
Bill C-4 proposes a full GST rebate for first-time buyers on homes up to $1 million, but is that enough to move the needle on affordability?
In our latest Housing Affordability Watch, we explore what Bill C-4’s changes could mean—and why, without a deeper understanding of seniors’ housing needs and preferences, alongside expanded targeted housing supply, meaningful progress may remain limited.
Read the full analysis here: Does the GST Rebate on Housing Go Far Enough?
Independent Opinion
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