Canada鈥檚 central bank will aim to keep the annual pace of price gains at its historic target rate, but will now more formally take into account the health of the job market as part of its inflation-targeting regime.

A new framework agreement between the federal government and the Bank of Canada announced Monday keeps at its heart a two-per-cent annual inflation rate.

However, the central bank will now also consider employment levels and how close they are to the highest level they can reach before fuelling inflation when setting its trendsetting interest rate.

Bank of Canada governor Tiff Macklem and Finance Minister Chrystia Freeland stressed there was no material change to the bank鈥檚 marching orders, and that the consideration of employment does not constitute a dual mandate to hit two different targets 鈥� a measure that was under consideration for the mandate.

The two framed the agreement as codifying the Bank of Canada鈥檚 interest in a healthy labour market, something the bank has stressed during the pandemic in explaining its moves.

鈥淢onetary policy works better when people understand it,鈥� Macklem said, 鈥渁nd, really, this agreement clarifies our objectives and it clarifies how we have and can use the flexibility that is built into our framework.鈥�

Under the new agreement, the Bank of Canada may decide to allow inflation to sit closer to either end of the bank鈥檚 target range of one to three per cent for short bursts as it determines when the labour market hits its full potential.

It also has flexibility to keep its key interest rate at the lowest level possible for longer stretches to help the economy recover from a downturn.

Since 1991, the Bank of Canada has targeted an annual inflation rate of between one and three per cent, often landing in a sweet spot at two per cent.

Even under those previous mandates, the health of the labour market was a factor in decisions about whether to lower or raise rates, said BMO director of Canadian rates Benjamin Reitzes.

鈥淐ase in point, inflation is near five per cent and slack in the labour market has been a key reason why the (Bank of Canada) has kept policy rates at the lower bound,鈥� he wrote in a note.

The Bank of Canada鈥檚 key policy rate since the start of the pandemic has been at 0.25 per cent, lowered there to prod spending during the COVID-19 induced downturn and subsequent rebound. As it stands, the bank doesn鈥檛 see a rate bump until April 2022 at the earliest.

Changes in the Bank of Canada鈥檚 target for the overnight rate influence the prime rates at the country鈥檚 big banks that are used as a benchmark for loans such as variable rate mortgages and home equity lines of credit. Changes in the rate may also influence bond yields, which can lead to changes in fixed rate mortgages and other borrowing.

Under the agreement Monday, the central bank said the rate may more often hit rock-bottom and remain there for longer if the bank believes it will help get inflation back on target.

A low-for-longer rate environment may sometimes be needed, the bank said, even if it boosts the likelihood that inflation could overshoot the two per cent target as the economy recovers.

Rate hikes could be more gradual than in the past as the bank figures out if it has properly estimated the full potential of the labour market, meaning that inflation could again rise above the bank鈥檚 target.

鈥淭his is one reason to think that inflation will, on average, be higher in the coming years than in the past decade, albeit not dramatically so,鈥� said Stephen Brown, senior Canada economist with Capital Economics, noting inflation has averaged 1.7 per cent since the global financial crisis.

The bank noted that figuring out when the country has hit 鈥渕aximum sustainable employment鈥� may be 鈥渋mpossible鈥� because it can鈥檛 be nailed down to one number, and is complicated by a greying workforce and increased digitization.

The bank plans to outline what labour market markers it is monitoring and detail those as part of its regular interest rate announcements.

The deal also outlines how the bank should consider climate change in its policies, although leaving it up to governments to hit emissions targets. 鈥淢onetary policy cannot directly tackle the threats posed by climate change,鈥� the statement reads, latter adding that economic modelling should account for its affect on the financial system.

Alex Speers-Roesch with Greenpeace said that on the contrary, central bank policy can assist in fighting climate change. He pointed to the option of the bank buying more environmentally friendly assets, which the Bank of Canada is considering.

鈥擩ordan Press, The Canadian Press