MNI INTERVIEW: Canada Could Hike To 4.75%-WLU Researchers

Canada's central bank could raise its key lending rate to 4.75% or even further according to researchers modeling policymakers' previous reactions to price swings and the economic outlook, in an analysis that supports a more hawkish view than that of most investors.

That endpoint suggests several further rate increases of more than a quarter point are needed according to the research by Christos Shiamptanis and Ke Pang of Wilfrid Laurier University. Their paper, based on internal projections by the central bank recently made available with a multiple-year lag, shows that the BOC has over the years tended to respond more to signs of lasting deviations from the inflation target. (See MNI INTERVIEW: BOC Already Faces Wage-Driven Inflation - CFIB)

“We are going to see at least 50 basis points” in September, based on current trends and the economic modeling, Shiamptanis told MNI. “We are going to continue seeing rate increases for some time” and likely ones larger than a quarter point, he said.

While many market economists see the 2.5% overnight rate rising 75 basis points to 3.25% at the Sept. 7 meeting, they also generally expect the cycle to end within a few months at around 3.5%. This would be in line with Governor Tiff Macklem's remarks that he could hike rates to just beyond a neutral range of 2%-3% to return inflation to target from about 8% now.

Shiamptanis says the model he's created with Pang doesn't take into account the Bank's current internal inflation forecasting or the judgement of officials like Macklem, an important consideration at a time of big swings fed by supply chain shocks and the Ukraine war. At the same time, he said the Bank has also given other hawkish signals.

DOING WHATEVER THEY CAN

“The central bank is trying to do whatever they can so that people’s inflation expectations remain at 2%, so they will expect inflation to come down to 2%,” he said.

But Shiamptanis pointed to the Bank's July forecast showing price gains exceeding the target until the end of 2024 and added that he agrees that “we’re going to see increases of more than 2% for some time.”

The Bank is unlikely to need any sudden reversal of rate cuts, Shiamptanis said. Higher rates will slow growth and inflation and tackle a “mismatch between supply and demand" rather than causing outright setbacks. RBC and Desjardins economists are predicting a mild recession as rates rise and shock the hot housing market.

“If we move into negative territory then I do think the Bank of Canada will respond," Shiamptanis said. “I do not expect that we’re heading into a major economic downturn because of the rate increases."

The research by Shiamptanis and Pang also shows that the Bank tended to react more forcefully when inflation falls below target than when it overshoots.