Home Economy The Bank of Canada’s inflation battle has reached a tipping point

The Bank of Canada’s inflation battle has reached a tipping point

by SuperiorInvest

Kevin Carmichael: There’s a good case for holding rates now, but it’s probably not enough for the central bank

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The Bank of Canada will announce the conclusions of its latest round of policy talks on January 25 at 10:00 a.m. Ottawa time. The safe bet is that Governor Tiff Macklem will give the green light for a quarter-percentage-point increase, which would lift the benchmark rate to 4.5 percent and extend the most aggressive rate-hiking streak in the central bank’s history.

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Most analysts predict that politicians will then decide enough is enough and stop. But that’s not guaranteed.

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David Rosenberg, a widely read Bay Street economist and Financial Post contributor, thinks the Bank of Canada and its peers have already raised interest rates too high, setting the stage for a recession that has already begun. If Macklem and his representatives have read Rosenberg, they will be reluctant to push borrowing costs higher.

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Yet inflation – now around six percent — remains far from the Bank of Canada’s two per cent target. Cost pressures are easing, but perhaps not fast enough for an institution mandated to achieve price stability. In other words, the credibility of the Bank of Canada is at stake. That’s one reason why most professionals who are paid to predict the trajectory of Canadian interest rates say Mackle will raise the benchmark rate at least once more. Veronica Clark of Citigroup Global Markets Inc. thinks one more hike will be needed in March to bring inflation under control.

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So this week’s policy decision will be a key moment in Macklem’s fight against inflation. Here’s what you need to know:

Data dependency

The Bank of Canada’s decision to raise the benchmark rate by half a point in December was classified as a surprise, with Bay Street settling on a smaller quarter-point hike as the most likely outcome. By opting for another excessive hike (central banks generally prefer quarter-point moves up or down), Macklem showed that he errs on the side of crushing inflation when looking at the mixed-signal panel.

But despite the increase, the central bank said the game had changed. Policymakers decided against raising interest rates in January 2022, but strongly indicated they would raise the benchmark rate in a policy update five weeks later. They went on to conclude a series of policy meetings where the only question to be considered was how high? With headline inflation nearing June’s peak of 8.1 per cent, Bank of Canada leaders knew they would spend much of the year playing a high-stakes chase game.

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By the end of the year, Canada’s inflation fever seemed to be bursting. As the politicians administered another dose of hard medicine, they said they would be willing to give their patient a break in the new year.

“We have indicated that going forward we will consider whether to raise rates further,” the deputy governor Sharon Kozicki said in a Dec. 8 speech, “What we’re saying is that we expect our decisions to be more data-driven.”

Macklem’s dashboard

Data published since early December is mixed. Year-on-year gains in the consumer price index slowed to 6.8 percent in November (from 6.9 percent in October) and then to 6.3 percent in December. That alone could be enough to convince Macklem and his representatives to stop raising interest rates.

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However, the central bank began aggressively raising interest rates as it concluded that demand had outstripped the Canadian economy’s ability to keep up, creating a supply-demand mismatch that can only lead to inflation. The Canadian economy still had a lot of heat at the end of the year. Employers created more than 100,000 jobs (the unemployment rate fell to five percent, one of the lowest marks in history) and retail sales and restaurant visits were floating. Economists who doubted that inflation could be tamed without a spike in unemployment are now eating their forecasts. “Core inflation appears to be moderating without a recession,” said Douglas Porter, chief economist at the Bank of Montreal. said Stephanie Hughes of the Financial Post. “My chances of landing a soft landing have been slowly increasing over the past three months.

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The central bank will be worried by its latest quarterly surveys businesses and consumers. Both showed that confidence weakened in the fourth quarter, but that’s not what will bother policymakers. Forty percent of respondents to the Business Outlook survey said it would take until 2026 or later for inflation to return to two percent, and most consumers said they thought inflation would be around five percent in two years. These results suggest that inflation is becoming a self-fulfilling prophecy, something Mackle was desperate to avoid.

Why Mackle can go on

Headline inflation is falling, but core measures that correct volatile prices, such as gasoline, are firmer. For example, Statistics Canada’s consumer price index, excluding food and energy, has risen 5.3 per cent since December 2021, down only slightly from 5.4 per cent in November. Commodity prices caused the initial price increase, but the main driver is now a combination of demand, expectations and lagged effects contracts signed when inflation peaked last year.

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“There is not enough evidence to say with certainty that inflation is clearly on the way back to the 2 percent target,” Royce Mendes, an economist at Desjardins Group, said in a note.

The central bank doesn’t like to admit it, but its policy decisions determine the mood in the housing market. Rising borrowing costs have hit the housing industry hard, although builders and mortgage brokers have been riding the wave of irrational exuberance for years. Housing markets are finally starting to look affordable. A decision to pause could make the Bank of Canada look weak and bolster bets in the bond market that policymakers will cut interest rates before the end of the year.

“The BoC needs to consider that its actions could reignite future risks to housing affordability,” Bank of Nova Scotia economist Derek Holt said in a note last week.

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Why Mackle can take a break

The Bank of Canada will also update its economic outlook this week. Its October quarterly outlook had inflation averaging 7.1 percent in the fourth quarter. Instead, the year-on-year increase in the consumer price index averaged 6.7 percent. Politicians are gaining ground faster than they thought. Rather than raising the risk of a recession with another spike, it might be time to take stock — and perhaps even signal victory.

Monetary policy works with a lag, so we have yet to see the full effect of higher interest rates. Rosenberg thinks it could get ugly, given that Canadian households have accumulated so much debt over the past decade that housing prices have skyrocketed. Many of them will now use more of their disposable income to pay higher debt servicing costs rather than contributing to demand. Macklem doesn’t want to be remembered as the governor who let inflation off the leash, but he also won’t want to be known as the central banker who caused a painful recession.

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“While labor markets remain very tight, inflation has been cooler than expected in recent months and the housing market continues to struggle,” the National Bank’s economic team said in its latest weekly outlook on economic conditions. “As such, we would argue that the prudent approach is to stay away at this point, but we recognize that this decision could easily go either way.”

Bottom Line

There’s a good reason to stop. Elevated debt levels and years of extremely low interest rates have likely made the economy very sensitive to higher borrowing costs, meaning pain is coming. However, the data since December does not appear to meet the Bank of Canada’s own criteria for a pause. Kozicki said the central bank will need to see definitive evidence that inflation is heading back toward target. The stickiness of core prices and evidence that a significant number of businesses and consumers expect price pressures to continue suggest that inflation could stop falling before reaching two percent. This will concern politicians the most. They care about growth, but ultimately their mission is to get inflation back to two percent. We still have a long way to go.

• By e-mail: kcarmichael@postmedia.com | Twitter: carmichaelkevin


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