The BoC will have to hike rates as high as 6% to take down strong inflation: Earl Davis
Bank of Canada officials could finally acknowledge the risk of the Canadian economy falling into a recession at the bank’s interest rate meeting next week, a top Bay Streeter said.
“The Bank of Canada is going to stop dancing around recession risk in the sense that they'll acknowledge that, you know what, the chances of a recession are high,” said Earl Davis, the head of fixed income and money markets at BMO Global Asset Management, in an interview Wednesday.
In the bank’s communications from the July 13 rate decision, officials said they expect a “soft landing” for the economy and for growth to continue, albeit at a slower pace, and have so far resisted using the word “recession.” However, that could change at the Sept. 7 meeting, according to Davis.
Should Davis’ prediction come true, it would come on the heels of a speech by U.S. Federal Reserve Chair Jerome Powell on Aug. 26 when he warned of economic “pain” stemming from higher interest rates. Many economists took his speech to imply the Fed chair has abandoned his hope for a soft landing in the U.S. economy.
“With a singular focus on inflation, you actually have to break the back of inflation and you have to keep raising rates until you get to that point,” Davis said.
He is sticking with his call for interest rates to rise as high as six per cent in Canada. Currently, the Bank of Canada’s main policy rate is 2.50 per cent, with another half-point hike widely expected Sept. 7.
Since changes in monetary policy take time to ripple through the economy, Davis said he thinks the tightening path won’t be as linear as before.
“Where the challenge comes, is that when the central bank hikes interest rates, they usually say that takes 18 months to go through the market. So we haven't felt the brunt of the hikes as of yet. That will be the second half of next year,” he said.
Davis said he expects interest rates to reach and hover around four per cent for some time while the bank gauges the economic impact before it starts to hike again to finish the job on tamping down inflation to the two per cent target.
“So in a sense, the easy hikes for the central banks are done after this next hike because of strong inflation, strong job growth as well and more (job) vacancies. Where the challenge comes from for the central bankers — we still have high inflation, the hikes that they've done haven't yet bit — so how much more do they hike?”
Inflation has shown signs of a slight cooling in Canada but it’s still nowhere near the Bank of Canada’s target. Davis explained he’s expecting inflation to plateau around five per cent, meaning interest rates need to be above that level for them to be restrictive, which is the reason underpinning his expectation for rates to hit six per cent.