Some Bay Street economists believe the Bank of Canada can likely wait a little longer to raise its benchmark interest rate, despite inflation running well above the central bank’s target and the risk that poses to household spending.
“If you believe most of the increase in inflation is temporary, then [the Bank of Canada] likely can wait a bit longer,” Sal Guatieri, senior economist and director at BMO Capital Markets, said in an interview.
“The unemployment rate is still a percentage point above the decade lows we got to before the pandemic. Wage growth is still pretty subdued in Canada — with average hourly earnings running at a two per cent yearly rate. So, on that basis, they probably could afford to wait.”
Capital Economics Senior Canada Economist Stephen Brown agreed. Canada is only starting to see the “first signs” of wage growth, he said, adding that a lot of the inflationary pressures we’re seeing in the country are due to domestic and global supply chain constraints — something Brown believes the Bank isn’t as concerned about because it’s less likely to feed into permanent price increases.
Markets widely expect the Bank of Canada to leave its benchmark rate unchanged on Wednesday despite inflation running hot.
Statistics Canada data showed consumer prices soared 4.7 per cent in October on an annualized basis — the largest increase since February 2003.
Governor Tiff Macklem himself has put Canadians on notice that the Bank could start hiking rates as early as April, but both Guatieri and Brown don’t foresee the central bank's tightening cycle beginning until July.
However, there could be risks to waiting that long.
“I think one of the chief risks is that inflation expectations that we've worked so hard at, for so long, risk becoming de-anchored,” Warren Lovely, managing director of economics and strategy at National Bank, said in a phone interview.
Lovely is predicting the initial Bank of Canada hike will occur in April.
In his view, factors such as a Canadian economy that’s operating near full potential, a labour market that’s close to full employment and, of course, high inflation all make “good arguments for scaling back what is still just an extraordinary, stimulative, monetary policy, and probably doing it quicker and starting a process sooner than the summer.”
PEAK INFLATION?
The main question for the Bank of Canada is how long inflation will remain at these high levels.
“Most analysts, including ourselves, believe inflation will moderate or begin to moderate by the spring of next year, and move back to pretty close to the midpoint of the central bank's target range by the end of next year,” Guatieri said, acknowledging that outlook depends on the course of the pandemic and whether the Omicron variant prolongs supply chain disruptions.
He added if his forecast pans out, it could buy the central bank some time in delaying its tightening cycle, since inflation would be “moving in the right direction.”
Brown pointed out some inflationary pressures have already started to ease, with oil prices falling and the fact that car prices should start to decline now that the semiconductor shortage has improved.
“I think it’s pretty unlikely that we see inflation sustained at five per cent in six months time,” Brown said.
CONSUMER SPENDING IMPACT
Despite those early signs that consumer prices could be poised to ease, if inflation is allowed to run rampant for too long, it could impact household spending — a key pillar of the Canadian economy.
“I think that’s something that’s going to play into the Bank’s mind, and really, that’s why it’s such a challenge for the Bank at the moment — because it’s trying to weigh the risk of inflation being sustained higher and the probability that inflation could actually harm the economy to some degree,” Brown said.
He also thinks the Bank’s ability to raise rates could be hampered considering how low rates have fuelled the housing market — another crucial economic sector.
“In the pre-pandemic tightening cycle, when the bank got rates to 1.75 per cent, [it] had to bring the rate hike cycle to a premature end because we saw a big reduction in residential investment and in the related component of household spending,” he said.
Brown sees the Bank bringing overnight rates to one per cent by early 2023, with the caveat that it will have to pause by then because of subsequent economic weakness.
“I just don’t see how the housing market could possibly sustain a rebound in mortgage rates back to pre-pandemic levels or even higher,” he said.
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