MNI: Bank Of Canada Is Lagging On Rate Cuts- CD Howe

MNI (OTTAWA) - The BOC is lagging on rate cuts with a model linked to how officials say they react symmetrically to misses of their target suggesting borrowing costs should already be a quarter- to a half-point lower, according to an upcoming paper from the C.D. Howe Institute.

Governor Tiff Macklem could have started cutting rates in Q1 rather than its opening move in June according to co-authors Ke Pang and Christos Shiamptanis, who teach at Wilfrid Laurier University. That result is based on a review of the Bank's internal forecasts made available since inflation targeting was adopted in 1991. Since those internal projections are delayed from publication for five years, the recent experience is based on forecasts in the Bank's quarterly Monetary Policy Report. 

The findings mesh with investor bets the Bank will shift to a half-point cut in its decision Wednesday following two other 25bp moves in July and September. Economists surveyed by MNI say that with inflation fading to 1.6% and Q3 growth coming well short of the Bank's 2.8% projection faster relief is needed. (See: MNI INTERVIEW: BOC 'Hard Discussion' On 50BP Cut- Ex Staffer)

Similarly delayed tightening after the pandemic rebound as inflation soared to 8% has been costly to the economy and the Bank's reputation, Pang and Shiamptanis wrote. While officials say they care equally about inflation coming above or below target, the authors found that after the initial stabilization of prices in the 1990s under CPI targets the Bank's focus shifted to negative undershooting and more persistent deviations from target.

The C.D. Howe Institute runs a shadow monetary policy council and has been advised by numerous former top BOC officials.

MISSING THE MARK

The BOC, like many other central banks, appeared to be `fighting the last war' coming out of the pandemic, worried about choking off a recovery as many felt was the case after the 2008 global financial crisis. The gap between a symmetrical inflation policy and the Bank's actions peaked in early 2022 as the Bank began hiking rates from near zero in March. 

"The Bank’s own forecasts at that time unveiled that the average annual inflation rate over the next two-and-a-half years was expected to remain above 5% and the economy two quarters ahead was expected to be above its full employment level," according to the paper.

That tightening much more closely followed a model based on a "negative deviations scenario" where officials respond more to downside inflation risks, the paper showed.

Officials appear to have fallen behind again this year based on their Q2 projections, under both the symmetrical and the negative deviations approach, the authors wrote. (See: MNI INTERVIEW: BOC Cuts Will Be More Hesitant- WLU Researcher) 

"The important lessons learned from the recent experience are that a) the Bank should respond when its own forecasts reveal that expected inflation over the next two to three years is going to be persistently away from the 2% target, falling outside the inflation target range, and b) they should respond in a symmetric way to these deviations," the authors said.