Bank of Canada Governor Tiff Macklem’s decision to deliver the biggest interest rate hike in a generation hasn’t sapped his optimism about the nation’s outlook.

Though he surprised markets by cranking up the policy rate by a full percentage point to 2.5 per cent, Macklem tried to fuse his hawkish language around inflation with a soft-landing scenario as the most likely outcome in Canada.

Economists say that will be a challenging feat. 

Doing so assumes that the tightening cycle will be short-lived with rates barely moving into restrictive territory, and that the combination of high inflation and a weak housing market doesn’t seriously derail consumer spending. The central bank still sees Canada’s economy growing by 1.8 per cent next year and 2.4 per cent in 2024 -- a Goldilocks scenario.

The rosy outlook comes with a big risk. A wrong call on economic growth would be another blow to the central bank’s credibility, which is already in question after repeated errors in forecasting inflation. 

“A soft landing here is a bit like trying to parallel park a car at 60 miles an hour,” Mark Wiseman, chair of Alberta Investment Management Corp., said on BNN Bloomberg Television. “You have to be not just a skilled driver, but an extremely skilled driver and a little bit lucky.”

PREVENTING A SPIRAL

According to the Bank of Canada’s new forecasts, the rate shock it just delivered will keep inflation expectations in check, restraining wage demands and price increases. That’s projected to bring price pressures back down to near 3 per cent by the end of next year -- removing the need to raise borrowing costs too far into restrictive territory.  

Macklem told reporters after Wednesday’s decision that the policy rate may only need to rise slightly above 3 per cent, the top end of what the bank considers the neutral range, in order to prevent a wage-price spiral. 

While acknowledging “the path to this soft landing has narrowed” because of elevated inflation, he’s been reluctant to speculate on the likelihood of a sharp downturn.

“Our goal is to get inflation back to its 2 per cent target with a soft landing for the economy,” he told reporters in Ottawa.

What Bloomberg Economics Says...

“A steeper set of inflation forecasts and stiffer price expectations in consumer and business surveys warranted following through on last month’s threat to ‘act more forcefully if needed.’ Even after downgrading the growth outlook to 2.6 per cent this year (vs 3.8 per cent prior) and 1.8 per cent in 2023 (vs 2.9 per cent prior), the central bank may opt for another 100-bp move in September.”

--Andrew Husby, economist

To some analysts, that’s difficult to reconcile with tough talk on rates and inflation. 

“Given the extremely aggressive rate hike, that more hikes are coming, and the multi-decade highs in inflation, the path to a soft landing for the Canadian economy may not be achievable,” Benjamin Reitzes, a rates strategist with Bank of Montreal, said by email.

Markets emerged from the rate decision more convinced the tightening will be accompanied by a sharper slowdown.

The yield on sovereign two-year debt has jumped 16 basis points over the past two days, trading at 3.36 per cent at 11:08 a.m. Thursday in Toronto. That’s about 20 basis points higher than the 10-year yied -- an inversion in the curve that is a potential signal investors anticipate a recession is coming.

Trading in overnight swaps showed that expectations for the policy rate by the end of the year is at 3.75 per cent.

To square his hawkish language on inflation with his growth outlook, Macklem introduced a new argument on Wednesday. He said aggressive rate hikes now -- what officials call “front-loading” -- actually lower the likelihood of a recession and the need to chase escalating inflation expectations in the future.

“By front-loading interest rate increases now, we are trying to avoid the need for even higher interest rates down the road,” Macklem told reporters.

Economists, though, appear to be more willing to assign a higher probability to a bigger slowdown.

“Recession is technically not the base case, but I do see it close to coin flip. You do have a lot of downside risk when it comes to housing,” said Citigroup economist Veronica Clark, who now sees the central bank hiking the policy rate as high as 4 per cent.