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May 30, 2022
BOC faces credibility test in political firestorm over inflation
I would describe inflation right now as an emergency: Philip Cross
If worrying about an overheating economy wasn’t enough trouble, Bank of Canada Governor Tiff Macklem enters a crucial six-week period in his battle against inflation with an unexpected new problem: questions about his own credibility.
The 60-year-old central banker is being targeted by prominent politicians from the opposition Conservative Party who are casting doubt on his commitment to the fight. And while most economists and pundits have dismissed the criticism as frivolous, the attacks come at a tense time.
The Bank of Canada is in the middle of a shock-and-awe campaign to bring down inflation, hoping to bolster public confidence that it’s serious about tackling the problem. The more credible the central bank is perceived to be, the more price expectations will remain in check -- and the greater the chances of a soft landing.
Macklem is expected to press ahead with three consecutive half-percentage-point hikes over a three-month span. The first jumbo hike came in mid-April, odds are the second is coming at a policy decision this week and a third is likely due in the first half of July.
“If Tiff is worried about his credibility, what he probably has to do -- and this is the unfortunate thing -- is he probably has to overdo it, in terms of interest rate increases and risk a little bit more,” Chris Ragan, director of the public policy school at McGill University in Montreal, said by phone.
The bank’s policy interest rate, which began the year at a record low of 0.25 per cent, is expected to hit 2 per cent at the July 13 meeting. It’s a front-loading of force aimed at convincing households and companies the inflation spike won’t last, before they start recalibrating their expectations higher for wages and prices.
Markets seem convinced Macklem will succeed.
After the three oversize moves, the Bank of Canada is expected to slow down the pace of tightening. Three or four more hikes are priced in after that, but all quarter-point, and policy makers are seen stopping around the 3 per cent mark.
That’s well short of what’s currently considered a high “contractionary” rate -- which means there’s no perceived need to orchestrate a sharp slowdown to rein in price pressures or repair the central bank’s credibility.
What Bloomberg Intelligence Says...
“We believe that risks tilt to the upside. The Bank of Canada is likely to update inflation forecasts even higher in July. If price pressures persist into 3Q, it may be difficult for the central bank to pause in 2H, but a stepdown to 25 bps is certainly possible.”
--Angelo Manolatos, senior associate analyst, and Ira Jersey, chief US rates strategist
There’s also nothing alarming just yet in the data to suggest the central bank is too late to engineer a soft landing. Average wage growth has picked up to just over 3 per cent. That’s still well below inflation, which was 6.8 per cent in April, and not too far beyond what would be considered normal in non-crisis times anyway.
The pace at which companies expect to be jacking up prices has also plateaued in recent months, according to monthly surveys by the Canadian Federation of Independent Business -- a reassuring sign.
Yet as Macklem himself quipped in a speech a decade ago, credibility is hard to earn but easy to lose. That’s why the central bank isn’t taking any chances and is moving rates back to neutral as quickly as it can. The current policy rate remains extremely stimulative.
After all, it’s become clear -- at least after the fact -- that the Bank of Canada injected more stimulus into the economy than needed, and has been late to pull back. While it’s a stretch to blame Macklem for much of the current inflation in Canada, which is being driven by global factors, policy makers know they are stoking price pressures and have fueled a housing bubble.
The quick course correction comes because officials want to prevent any perception they’ve become more tolerant of inflation.
Macklem’s recent acknowledgment that some errors were made in response to the COVID-19 crisis was part of that. The mea culpa serves a purpose: reassuring Canadians the spike in prices wasn’t by design.
If anything, the political attacks will accelerate what’s likely to be a years-long postmortem on Canada’s stimulus efforts during the pandemic -- for both the Bank of Canada and Prime Minister Justin Trudeau.
That’s not a bad thing, and the central bank appears to be open to the debate.
“Tough questions, added scrutiny and informed debate are entirely appropriate in the current environment,” Senior Deputy Governor Carolyn Rogers said in a speech this month.
That postmortem will likely include whether the central bank has strayed too far from its core mandate, a discussion that will be welcomed by many economists.
There’s been an erosion of trust between the central bank and Conservatives that predates the pandemic and that’s an untenable situation for an institution whose effectiveness hinges on credibility.
Most recently, the front-runner to win the Tory leadership, Pierre Poilievre, announced he would fire Macklem should he ever take power, which is within the realm of possibility.
While most dismiss the 42-year-old lawmaker’s rhetoric as bluster, it’s also not hard to find concern bubbling that the central bank had lost focus on inflation and may have been too accommodating to politics. It’s a debate going on in other countries as well, including growing scrutiny at the Bank of England and the Federal Reserve.
In Canada, look no further than the central bank’s renewal of its inflation-targeting mandate last year, which looked uncomfortably political to many. Ragan and other economists complained that the introduction of language around maximum employment and climate change appeared as if it had been written by Finance Minister Chrystia Freeland’s office rather than Bank of Canada officials.
“The answer is to get inflation down,” William Robson, chief executive officer of the C.D. Howe Institute in Toronto, said by phone. “If inflation stays high, this problem is not going to go away, no matter what we think of Pierre Poilievre.”
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