MNI: BOC Says Real Rate May Need To Remain Elevated

Bank of Canada Deputy Governor Sharon Kozicki said Tuesday the toughest inflation battle in decades means real interest rates may need to remain elevated, reiterating that after a pause in September officials are balancing the risks of over- and under-tightening and can hike again if progress restoring price stability stalls. 

"Inflation has come down, but it is still too high. And that tends to mean that real interest rates need to remain high," she said in the text of a speech she's giving in Regina, Saskatchewan. 

Most of her remarks about the current outlook echoed the Bank's decision earlier this month to hold its benchmark overnight lending rate at the highest since 2001 at 5%, keeping the message about signs rate hikes are working but more may be needed. A report earlier Tuesday showed headline inflation quickened more than economists expected to 4% in August. Core inflation measures also accelerated in August and Kozicki said there has been little "downward momentum" in trend inflation.

"We balance the risks of under- and over-tightening monetary policy," she said. "We know that if we don’t do enough now, we will likely have to do even more later. And that if we tighten too much, we risk unnecessarily hurting the economy."

Inflation remains well above what's consistent with restoring inflation to the 2% target, she said, reiterating "we are prepared to raise the policy interest rate further if needed." Market bets on an 11th hike from near-zero rates set during the pandemic increased after Tuesday's CPI report, though most economists say the Bank is likely done hiking as the lagged effects of tightening take hold. 

Recent data suggest higher rates are slowing demand, she said, adding that first-quarter consumer consumer spending may have been propped up by special factors and the second quarter figures suggest a genuine slowdown. "We are mindful that past increases in interest rates will continue to weigh on activity," she said.

Much of the speech focused on how low-for-long interest rates and Covid disruptions appear to have altered the transmission of monetary policy with a greater dispersion of household finances between the heavily indebted and wealthier people. While two-thirds of Canadians are home are owners, she underlined that the jump in mortgage rates alongside BOC hikes may depress spending for much longer than in the past.

"Low for long, in particular, implies that all five-year fixed-rate mortgages issued before 2022 will likely face significantly higher interest rates when they are renewed," she said. "That is what has been happening, and it could continue for an additional three and a half years. The resulting drag on spending could last even longer."

The speech also had some of the Bank's most candid language yet on how low-for-long rates fed a boom in housing and consumer debt, something that along with the inflation surge has rattled the fortunes of Justin Trudeau's Liberal government and led other politicians to attack the central bank. Kozicki also noted that real interest rates have only recently turned restrictive amid what she called the biggest challenge to inflation targeting since Canada took on that framework in 1991. 

"Even before the pandemic, interest rates had been very low for a long time and some households had accumulated considerable debt. The current elevated debt levels have affected how higher interest rates affect individual households and have changed the relative importance of the channels through which monetary policy is transmitted," she said.

"Balancing the pandemic paradox of accumulated debt and accumulated wealth has been a defining feature of monetary policy considerations during this cycle of tightening," she said. "Gauging the overall impact of these changes on the transmission of monetary policy is key to determining the appropriate degree of tightening."