MNI INTERVIEW: BOC Has Little Room For Aggressive Cuts- Spence

Lingering inflation risks and chronically weak productivity in Canada's economy leave little room for the central bank to deliver aggressive interest-rate cuts through the rest of this year, former adviser Andrew Spence told MNI.

“They’ve got the confidence to start reducing interest rates but they do not have the confidence to reduce them decisively,” said Spence, a senior adviser at Validus Risk Management in Toronto. “The only signal is that we cannot commit to monotonic, bold interest rate reductions when the world is as uncertain as it is, and we’re just coming off a period of much higher inflation.”

The rate-cutting path remains unclear given forecasting misses that roiled global officials when inflation surged after Covid lockdowns, Spence said in a phone interview. Even as Governor Tiff Macklem leads G7 central banks with back-to-back cuts and signals more can be justified as inflation slows, he pointed to more limited prospects for investment and growth to restrain prices.

Spence's caution comes as some economists are shifting projections to rate cuts at each of the Bank of Canada's three remaining meetings this year, and some experts such as RBC suggesting a 50bp reduction can't be ruled out. (See: MNI INTERVIEW: BOC Will Cut At Next Three Meetings- Sen Gignac) None of the economists tracked by MNI see the Bank's current 4.5% rate moving below 3.75% this year, though Capital Economics says borrowing costs over this cycle will fall below a neutral rate around 2.75%.

MORTGAGE RESETS LOOM

“It’s very difficult to forecast with any conviction that the overnight rate is going to be much below 4% by the end of this year, and that won’t be enough to prevent the lion’s number of households having to refinance their mortgages at much higher rates,” Spence said. Many of those mortgage adjustments will reflect most of the BOC's 10 prior rate hikes from 0.25% to 5% rather than the quarter-point cuts in June and July.

Modest rate cuts and rising unemployment will keep consumer sentiment downbeat well into next year when a federal election is due, Spence said. That could be significant for monetary policy with Conservatives leading in polls saying they will fire Macklem and favor a stricter inflation target.

“Food inflation and shelter inflation have eaten up much of the nominal wage growth in the last year, and there are lots of other things that are more expensive,” Spence said. “A good portion of the population is getting squeezed, and quite substantially.”

BREAKING LIFETIME HABITS

Canada has less potential than the U.S. to sustain much growth due to a lack of competitive industries and little evidence investment will drive the economy in the way the central bank projects, said Spence, who has a book coming out about Canada's competition policies.

Record immigration in recent years has added to the sense companies and governments will continue down the path that has left Canada lagging, he said. The Bank's own projections last week made adjustments to include the significant influence of population growth on the economy and to mark down labor productivity.

“It is not a recipe for long-term economic growth because if a company has to choose between expensive capital and the uncertainty of that, or very affordable labor from overseas, then they are going to choose the cheapest of those two,” Spence said. For a more competitive economy “Canada has to break the habits of an entire lifetime,” he said.