MNI INTERVIEW: BOC Can Wait On Rate Hike- UofT Researcher

The Bank of Canada needs a wait-and-see approach on further rate hikes to judge how accumulated tightening slows an economy still fueled by households enriched with pandemic savings, central bank research award-winner Claire Celerier told MNI.

Interest rates haven't risen this fast since the 1980s so the lagged impact isn't as clear according to Celerier, a University of Toronto professor who in 2022 won a BOC "Governor's Award" providing funding for up to two years. The Bank has hiked the overnight rate from a record low 0.25% early last year to 5% in July, the highest since 2001.

“Instead of acting too fast I think I would wait to see what the effects are before raising rates again,” Celerier said. “These lags are longer because of the huge amount of cash that has been accumulating in the economy during the pandemic.”

Bank of Canada Governor Tiff Macklem paused rate increases early this year after eight consecutive moves, but returned with quarter-point hikes in June and July on signs inflation could get stuck above his 2% target. Most economists say he will hold rates next month and may move again later this year.

CASH THROWN AROUND

“It’s true we don’t see the effect immediately now but in the economy there is always a lag, and so there are reasons to believe the lag is a bit longer these days because of all the cash that has been thrown into the economy,” Celerier said.

Canada posted record budget deficits during the pandemic and only wound down some major household benefits a few months ago. Provincial governments over the past year have sent out more checks even as unemployment fell to record lows. While the household savings rate has declined to 2.9% in the first quarter from 5.8% at the end of 2022 it's still above the pre-pandemic 2.1% according to Statistics Canada. (See: MNI INTERVIEW:Trudeau Pushes BOC To High-For-Long Rate-Asselin)

Macklem told reporters at a July press conference he's been surprised by the economy's resilience to higher rates and that he will act again if inflation remains too hot. The Bank pushed out its prediction of when 2% inflation is restored to mid-2025.

The Bank’s concern that it had waited too long before beginning to raise rates led it to act more aggressively once it started, Celerier said, noting that this was another element that makes figuring out the response to higher rates different than in past cycles.

CONSUMER DEBT INSTABILITY

Canada also faces "instability" from consumer debt levels which are higher as a share of the economy than in most developed nations, she said. “You have a lot of leverage in the economy, interest rates are increasing, a lot of people have to renegotiate their mortgage.” (MNI INTERVIEW:Vancouver Housing Revives After BOC Hit-Realtors)

Stretched demand is only part of the issue, with supply also potentially held back by weaker labor supply amid an aging population and younger people who may wish to work less, she said. Commodity production will be hampered by the Ukraine war and rules around more sustainable extraction, she said. “I would tend to think we are shifting to a world where supply is more constrained.”

Asked if this would change neutral interest rates, Celerier said there is a more of a political question around how higher inflation targets might shift wealth towards younger indebted people from older households. “What we aim at for inflation in the long run is going to affect the distribution of wealth in the economy.”

Stored-up fuel of fiscal and monetary stimulus is driving the economy at the moment, she said. “People keep spending today because of the savings of the huge amount of liquidity in the economy.”