MNI: BOC Still Needs Patience As Inflation Slows- Ex Staffer

The Bank of Canada is likely to remain patient before cutting rates despite headline inflation having slipped back within the official target band because there are too many potential flare-ups especially from real estate, a former central bank and finance department economist told MNI.

“The economy has been a lot more resilient to rate hikes than expected,” said Charles St-Arnaud, who now works at the credit union network Alberta Central in Calgary. “That’s important for the Bank of Canada’s thinking, that well, there is some resilience. And it might give them comfort that we really don’t need to hurry up too much.”

Core price indexes remain above the top of the 1% to 3% target band even as the headline rate slipped to 2.9% in January from December's 3.4%, and St-Arnaud said the core figures will be more influential with policymakers. Governor Tiff Macklem needs to see core inflation slow to around 2.5% before he could lower borrowing costs and that will likely take until the June or even the July meeting, St-Arnaud said in an interview.

The Bank's next rate decision is March 6 and the consensus is a hold with some investors seeing a rate cut in April alongside a new economic forecast. Macklem has said that while he's growing more confident the Bank has hiked enough to turn the inflation tide, serious talk of a rate cut can't happen until it's clear inflation will stabilize at the 2% target. St-Arnaud said March will be too soon for Macklem to significantly overhaul his message about the sequence of a policy shift.

PENT-UP DEMAND

Reasons for caution include workers winning 5% pay hikes and the threat of more of the geopolitical turmoil that has driven up commodity prices in recent years, St-Arnaud said. The economy many investors said is in for a hard landing also looks set to again beat the Bank's forecasts over the next few quarters, he said.

Housing remains the biggest upside risk because it could set off another round of frothy gains from consumers who have already shown incredible staying power as affordability melts away. (See MNI INTERVIEW: Peaking BOC Rate Rekindles Housing-Royal LePage)

“The Bank of Canada will want to be careful about that one and err more on the side of caution when they cut to not generate or to unleash tons of pent-up demand on the market that is already extremely tight,” St-Arnaud said.

The mortgage refinancing “cliff” from resetting loans at higher rates may be overblown when it comes to near-term spending because banks are allowing borrowers to extend amortization, he said. “As long as the labor market is holding and you don’t see job losses, I don’t have any concern,” about a spending slump, he said.

THE TREND MATTERS MORE

The Bank also has a more difficult job than usual in taming price expectations. St-Arnaud sees evidence consumers aren’t forward looking, suggesting inflation must be very close to 2% before officials can safely cut. (See MNI: Canadians Doubt BOC Wins Inflation Fight-Internal Polls)

In addition, the 5% benchmark overnight rate may not be very restrictive at a time when the neutral rate has likely been pushed higher, he said. Assuming the Bank's 10 rate hikes have eliminated excess demand and the economy isn't generating much underlying inflation, price expectations are still probably around 3%, he added.

Even if the first rate move is in June, St-Arnaud said his current view for 100bps of cuts this year may not be giving enough time to win the inflation fight. “We need to be careful, there might still be some flare-ups here and there, and the trend matters more.”