MNI INTERVIEW: Markets Overestimating Future Rate Hikes-Boivin

Investors betting on rate hikes by the Fed and other major central banks are misreading officials who enshrined greater inflation tolerance even before the pandemic and want to support rebuilding supply networks rather than use the traditional playbook of cooling overheated demand, BlackRock Investment Institute head and former Bank of Canada deputy Jean Boivin told MNI.

"Central banks at the end of the day will be providing a much more muted response to inflation," Boivin said in an interview. "If central banks were to move with what the market's suggesting now, this is literally like saying we're going to kind of like stop the restart."

Bank of Canada forecasts ahead of Wednesday's rate announcement show inflation exceeding the 2% target over a period that "would have been inconceivable" in the past, said Boivin, who also pointed to the Fed's mandate shift to an undefined overshoot a bit over 2% as an example of greater inflation tolerance.

Markets pricing in rate hikes around the world seem to be getting ahead of themselves, said Boivin, who served as BOC deputy governor from 2010 until 2012 and who earlier in his career did research with Ben Bernanke.

"It's remarkable, the fact that you've seen this massive repricing without an actual central bank meeting, right, it's not like there's been any decision made," he said. "It's all based on some central bank comments, I think the Bank of England in particular. And then there's been like a read-through from this by markets across all central banks so. So I think that's a shaky basis as a starting point for this view."

NO REPEAT OF 70S

Boivin's comments on the BOE are in line with MNI reporting that investors have likely read too much into Governor Andrew Bailey's comments that monetary policy can't tackle structural changes in the economy or supply bottlenecks. San Francisco Fed President Mary Daly last week also said that rate hikes could weaken the recovery and make it harder to reach full employment or the Fed's inflation goals.

Central Bank leaders with credibility will resist major rate hikes, said Boivin, adding that inflation today is different than in the 1970s when demand was surpassing economies working at full potential.

"Where there's a massive risk of confusion is the most important thing is not so much the timeframe, it's the nature of the shock. And it's the first time in 40 years plus that we're in an environment that is dominated by supply shocks, and that's a different type of inflation," Boivin said. "Central banks will need to think twice before like just mechanically look at this inflation and say we need to lean against it like we would do normally."

While inflation expectations may be important, they are harder to assess and make big judgments on, Boivin said. Policy makers who may be more concerned about expectations getting out of hand must also avoid setting that process in motion with their own words, he said.

"Ideally, credible central banks that have strong frameworks that have built a reputation over many years should be in a position now that they can take advantage of this credibility, more than others, and give them more ability to look through some of which you know are supply-driven shocks and not clamp down as much on the restart or prevent the restart from happening."

DEBT A BARRIER TO HIKES

High debt levels are another barrier to jacking up interest rates, he said, since fewer rate moves will be needed to slow down the economy. "We're going to see very vividly the impact of rising debt servicing costs, it's going to be a lot more real," Boivin said. "That's going to make it harder for central banks to raise rates as much."

The Fed in particular changed its mandate in ways that means a less jarring rate path because they left employment and inflation goals open to interpretation, Boivin said. Inflation when averaged even against the last several years has perhaps already met the Fed's goals, he said, so the fact the FOMC hasn't declared that victory is a sign of hesitancy to tighten next year.

"They want to maintain some room to maneuver and are okay with inflation overshooting even more," he said. "There's going to be at least a core part of the committee that will continue to say wait a minute, we are not there yet."