MNI INTERVIEW: BOC Could Hike Once Or Twice More, Dodge Says

The Bank of Canada and Federal Reserve could easily raise interest rates another quarter or half percentage point, former BOC Governor David Dodge told MNI, citing surprising job market strength and evidence of sticky wages and prices.

“We’ve been consistently learning over the past year that it’s just not having as much impact, and so we probably need a bit higher number,” Dodge said about higher rates. “I wouldn’t be at all surprised if the Fed and our Bank were to have to raise rates by another quarter, or even another half. It’s highly debatable if you need that and they are debating that themselves.”

Current BOC Governor Tiff Macklem boosted rates 10 times to the highest since 2001 at 5%, which is still below a benchmark closer to 6% when Dodge began his tenure in 2001, while the Fed has moved its policy rate to a range of 5.25%-5.5%.

“It may well be that everything below four, four-and-a-half percent was actually accommodative and we just haven’t applied the amount of restriction that is needed to open up that gap where supply would exceed demand,” said Dodge, now an adviser at the Bennett Jones law firm.

HIGHER FOR LONGER

Central banks are being challenged by the need for tighter policy to keep inflation expectations from bubbling up and political pressure for relief from soaring debt costs amid higher neutral rates, Dodge said. (MNI INTERVIEW: BOC Needs Hawkish Footing - Ex Deputy Minister)

Officials may consider a high-for-long policy to create the sustained period of below-potential growth needed to cool off overheated job markets, Dodge said. The sometimes rapid slowdown of inflation and wage gains over the last year may not be sustained and it's important to restore price stability at current targets, he said.

“To have everybody to have confidence that we’re actually going back to 2%, then indeed you have to err on the side of keeping rates higher for longer,” Dodge said. (See: MNI INTERVIEW: Canada Seen Hiking At Least 50BP More-WLU Prof)

Tradeoffs being debated by officials must draw the line at making sure price expectations don't flare up any further, Dodge said. Central bankers are aware of the pain of higher interest rates and must be kept free of political interference or knee-jerk calls to boost inflation targets, he said.

“If we lose control of the expectations, then what we are saddled with is higher aggregate levels of inflation and not only higher aggregate levels of inflation, but a tendency for that number to move up over time. Then we have tremendous social dislocation, we’ll be back into the situation we were in in the 70s,” said Dodge.

HIGHER NEUTRAL RATES

Dodge said the neutral rate of interest, one that neither stimulates nor slows growth, has likely risen significantly compared with prevailing estimates by the major central banks. (See MNI POLICY: Lively Debate At Fed Over Possible R-Star Rise) That's because of a range of factors including investments to fight climate change, soaring healthcare costs as Baby Boomers retire and a re-ordering of global supply chains to address geopolitical turmoil, he said.

"The neutral rate… is simply higher than the two to three percent which you will find in every MPR now for the past I don’t know how long," Dodge said, referring to the Bank's quarterly Monetary Policy Reports. Neutral rates in Canada and the U.S. are more like 3% to 4% and policymakers probably need an extra cushion of safety given the inflation pressures, he said.