The BoC will likely need to hike rates higher and faster: CIBC's Mendes
The Bank of Canada may have to adjust its view of its long-term neutral policy rate once a torrent of pent-up household savings is unleashed once pandemic restrictions are eased and, hopefully, eliminated, according to the Canadian Imperial Bank of Commerce.
CIBC Senior Economist Royce Mendes said in a report Tuesday that a sudden jump in consumer spending and any inflation that comes as a result could force the Canadian central bank to take a more nuanced view of where rates should be in the longer term.
“The stock of household savings built up during the pandemic could be used to keep spending buoyant, even as rates rise,” he said.
“All else equal, to keep the Canadian economy in a Goldilocks state after fully recovering from COVID-19, central bankers might feel some extra pressure to tighten policy, which isn’t captured by standard neutral rate models.”
The neutral rate is essentially where the interest rate needs to be to keep the domestic economy running at full potential while keeping inflation from rising out of control. Typically, full employment will lead to a tightening cycle, as the central bank adjusts rates to prevent bubbles from forming in asset classes like housing.
The Bank of Canada’s current long-term view has the neutral policy rate pegged at 2.25 per cent.
While the calculation of the neutral rate accounts for cyclical shocks to the economy, Mendes said the unprecedented conditions wrought by the pandemic could have long-lasting impacts and could force a shift in the Bank of Canada's methodology.
Mendes said it’s likely Canadian household balance sheets will have swelled by an excess $300 billion by the end of the year. That amount may not not be fully accounted by the Bank of Canada in terms of how it’s deployed once the pandemic passes, he added.
“The central bank seems too relaxed in its forecasts for spending over the coming cycle for a number of reasons. Excess savings aren’t actually any more tilted towards high-income earners than the flow of income reported by Statistics Canada,” Mendes said.
“Remember the Bank of Canada’s own data shows that Canadians mostly saved money because they didn’t have opportunities to spend rather than for precautionary reasons.”
While excess savings could, in theory, be spent on imported goods, reducing the odds of overheating the economy, and wages and inflation, Mendes said it’s unlikely that would blunt the inflationary pressures.
“Were excess savings only a Canadian factor, the additional spending in the years to come could have been satisfied by an increase in imports, and not necessarily by domestic production, which would keep the Canadian economy from overheating,” he said.
“But if other countries are faced with the same dynamics, there’s no escape valve for extra demand in Canada as additional foreign demand will just spill back into Canada.”