OTTAWA—The Canadian economy is in the midst of a rapidly rising interest-rate environment. The Bank of Canada is faced with trying to put out an inferno of inflation amid a red-hot economy while being criticized for the current predicament.
For the second straight meeting, on June 1, the BoC raised its policy interest rate by 50 basis points to 1.5 percent from 1 percent. A 50 basis points hike—a basis point is one one-hundredth of a percentage point—was widely anticipated.
“The Governing Council continues to judge that interest rates will need to rise further … is prepared to act more forcefully if needed to meet its commitment to achieve the 2 percent inflation target,” said the BoC’s June 1 statement.
The Bank of Canada and its governor, Tiff Macklem, have come under heavy criticism from Conservative leadership candidate Pierre Poilievre and economists, given that inflation has been exceeding the 3 percent upper limit of its target range since April 2021.
“The Bank of Canada is focused on maintaining its credibility, and ensuring inflation expectations remain anchored. With inflation poised to rise above 7 percent in the next print, the risks to expectations are skewed to the upside as well. That was no doubt the driver behind the ’more forcefully‘ language,’” said BMO strategist Benjamin Reitzes in a note.Vivek Dehejia, associate professor of economics and philosophy at Carleton University, says one takeaway for the central bank is that it can’t be complacent. He and others were saying last fall that inflation would be problematic, while the BoC waited and watched.
“There’s this sort of aura of invincibility and invulnerability and central banks know it all and they’re never wrong. So a little bit more humility, I think, would actually be welcomed,” Dehejia told The Epoch Times.
“There’s going to be a lot of uncertainty for individuals, maybe people looking to take on mortgages, businesses wanting to borrow for investment purposes.”
Dehejia added that what would help the public and investors plan better is having better guidance on what the BoC’s rate target is and what pace of increases to expect.
“I think it actually would be helpful if we had more explicit forward guidance from the bank. The Fed [U.S. Federal Reserve], for example, has been more explicit on the number of rate hikes and where they’re trying to go,” Dehejia said.
Philip Cross, senior fellow at the Macdonald-Laurier Institute, said in a May 31 interview with BNN Bloomberg that economists don’t have a good model for inflation, which appears to be broadly linked with the money supply and deficits. Both started ballooning in 2020.
“You would think central banks would have been hyper-vigilant to any upturn in inflation. Instead when inflation first turned up in 2021, they just dismissed it as transitory. Then they say ‘Oh this is due to supply shocks, and that'll go away.’”
Cross added that the BoC is not the only central bank at fault since the major central banks coordinate policy.
“If the Bank of Canada takes a radically different policy than the Federal Reserve Board, that’s going to have major implications for our exchange rate. So monetary policy has coordinated. The mistake that’s been made in Canada has been made elsewhere, notably by central banks in Britain, in the United States.”
Overheating Economy
“The economy is clearly operating in excess demand,” the Bank of Canada said.
It added that consumer price inflation “will likely move even higher in the near term before beginning to ease.” Annual inflation in April was 6.8 percent—the highest since the early 1990s.
First-quarter economic growth was 3.1 percent annualized—well above the bank’s April estimate of the economy’s potential growth rate of 1.7 percent for 2022—and the unemployment rate of 5.2 percent for April is a record low.
“This policy backdrop still calls for aggressive rate hikes in June and July,” said TD Securities following the May 31 release of March’s GDP.
RBC noted that rising rates are already cooling housing demand and questioned if rates need to rise above the neutral range to get inflation back under control.
The BoC in April estimated the neutral rate of interest—one that “neither stimulates nor weighs on the economy,” as Macklem described it—to be in a range of 2 percent to 3 percent.
Despite questions about the BoC’s credibility in fighting inflation, Cross says he believes the central bank is committed to its goal of getting inflation down to the 2 percent target.
“But every month that they go by, they’re behind the ball, you get worried and more and more inflation will become embedded in expectations, and especially in wages, and then it will become very difficult to wring out of the system, as we saw in the 1970s,” he said.
The C.D. Howe Institute’s Monetary Policy Council said that increases in inflation “have consistently outpaced forecasts, including those from the Bank of Canada for months.” Despite negative sentiment in financial markets and weakness in overseas growth, it said, “support from a growing U.S. economy and the strength of domestic demand in Canada meant that spending would continue to match or exceed productive capacity for the foreseeable future, and that higher short-term interest rates were necessary to bring inflation back down.”
Dehejia warns of the problem of expectations of future inflation becoming entrenched.
“The real danger, the real problem happens when inflation expectations get baked into the public thinking. If everyone expects inflation is going to be high, it automatically will be high because it gets baked into wage contracts, into pricing decisions, and you get this wage-price spiral. It’s kind of a vicious circle,” he said.
The central bank is also continuing its policy known as “quantitative tightening,” where it will allow its portfolio of government bonds to shrink as bonds mature, which gradually reduces the amount of stimulus in the economy. At the end of April, the Bank of Canada held over $417 billion in government bonds.
The bank previously said it would not actually sell bonds, which would put more upward pressure on longer-term interest rates and slow the economy further.
“It’s a fine balance between tightening monetary policy to cool off inflation, but not risk tipping the economy into recession,” Dehejia said, adding that there’s no formula for getting it right.
The Bank of Canada’s next set of quarterly forecasts will be published on July 13.
