MNI INTERVIEW: Aggressive Wage Bargaining To Extend BOC Hold

The Bank of Canada faces too many inflation obstacles to cut interest rates anytime soon with inflation now migrating to big wage demands, former top Statistics Canada economist Philip Cross told MNI.

“Rates are going to have to be higher for longer than the market had been assuming, because inflation is showing signs of being entrenched,” said Cross, a researcher at the Macdonald-Laurier Institute who had managed StatsCan's current economic analysis branch.

Many investors predict the Bank will cut the 5% benchmark rate around the middle of this year with some calls for a move in April. Governor Tiff Macklem has said that while he can look at loosening policy before inflation is all the way back to the 2% target the debate likely can't take place until it's clear price stability is being restored.

Wage bargaining has become aggressive even with unemployment pushed up amid record immigration, Cross said. He pointed to a strike lasting more than a month among a coalition of Quebec public sector workers, a west coast port strike last year and a major pay boost for unionized Ontario auto workers. Cross agreed with Macklem's reasoning that wage gains approaching 5% aren't consistent with price stability even with CPI slowing to about 3% from a peak around 8%.

'OUTBREAK OF MILITANCY'

“There’s been a serious outbreak of militancy in unions and I think that reflects the frustration that people have with the loss of their purchasing power over the last couple of years,” Cross said. “Clearly inflationary expectations are elevated.”

Upside inflation risks also include a "last mile" problem driving inflation all the way back to target, Cross said. Talk of rate cuts could also backfire by rekindling a stretched housing market or encouraging more government deficits that force the Bank to keep restrictive policy in place even longer, Cross said.

“The Bank pushing it down to 2% is not going to be as automatic as or as easy as I think markets had assumed,” Cross said. (See: MNI INTERVIEW: No BOC Rate Cuts Until Later In 2024-Conf Board)

“Either the economy turns down enough to bring down inflation that the Bank calls off the dogs, or they are just going to have to maintain interest rates at the current level and just let the ongoing pressure of people constantly renewing mortgages at higher and higher rates filter through the economy,” he said.

HIGHER NEUTRAL RATES

Canada's economy while slowing retains enough momentum to spark inflation, Cross said. Policymakers should also be chastened after misreading price pressures in the last few years he said, adding most models still lack understanding of price expectations.

“The underlying trend of the economy is not sufficient to really rein in inflation,” he said. “Core measures of inflation have been closer to 3.5%, so I think that is another sign that inflation is starting to get a little sticky.”

Longer-term prospects for easing are also crimped by bigger changes in the economy lifting neutral interest rates closer to where the Bank's policy rate stands now, Cross said. (See: MNI INTERVIEW2: Ex-BOC Chief Says Neutral Rate Is Rising) “We’re in a transition period from an extended period, well over a decade of low even approaching zero interest rates, and we’re returning to a world of more normal interest rates, where rates settle in at 4% or 5%,” he said.

The prospect of a major downturn in Canada or one imported from the U.S. can't be ruled out either, Cross said. That's especially true in a time when the last pandemic business support loans are coming due and commercial property markets are battered by high rates and a shift away from office work, he said.