MNI INTERVIEW: BOC Has Strong Case to Cut This Year-Ex Adviser

The Bank of Canada will have a strong case to reverse course and cut interest rates later this year as inflation slows and indebted consumers feel the growing weight of the fastest tightening cycle in decades, former special adviser Andrew Spence told MNI.

While Governor Tiff Macklem signaled a pause after the quarter-point increase on Jan. 25 and said he could hike again if needed, Spence said downside inflation risk is more relevant. Monetary policy looks tight following 425bps of hikes and the Bank's view inflation will slow to 3% this year and 2% in 2024 is more certain with the worst shocks from Covid and the Ukraine war fading, Spence said.

“If they hold interest rates where they are that means real interest rates, inflation-adjusted interest rates, are going up while the lagged effect of their tightening is coming through. That is a pretty compelling for an ease later this year,” Spence said by phone Monday.

“I find it difficult outside of a huge upside surprise to growth or inflation” for more tightening to be needed, said Spence, who was the first private sector economist to be invited to serve as special adviser to the governor of the Bank of Canada in the early 2000s and now runs his own consulting firm.

Spence's view contrasts with Macklem's comments that while inflation risks are balanced he's more concerned about upside risks with CPI so far above the 2% target. Other investors are more in line with Spence, with many calling for one or two cuts late this year as the economy flirts with recession.

WAGES REMAINING TAME

“When economies tip over, or begin to go down, they can get away from you very quickly, and the distribution of big downside surprises is greater and they are bigger on the downside often than they are on the upside,” Spence said.

Signs of a slowdown are emerging in less-noticed tallies of the money supply, Spence said, noting by one measure the pace has swung from 30% year-over-year growth to a 3.5% contraction. Money supply measures also did a good job predicting inflation that surged to about 8% last year, part of a longer successful track record, he said.

Pain will be more visible for low-income families being hit hard by tighter credit, Spence said, a problem exacerbated by wages lagging inflation. There's little prospect workers will sustain even the higher pay hikes they've won following the Covid lockdowns, he said.

“This sense that employees have the whip hand in labor markets is purely a temporary phenomenon,” Spence said.

Loose fiscal policy in Canada or energy price shocks from the Ukraine war remain upside risks, he said. “If fiscal policy imbalances deepen and that sustains demand for longer than anticipated and makes inflation control more difficult, the Bank of Canada will have no choice but to respond with higher interest rates.” (See: MNI INTERVIEW: Deficit Means Little Scope For BOC Cut- Asselin)

AVOID OVER-TIGHTENING

The major risk remains over-tightening, Spence said. The Bank has already been attacked for a "needless" recession by the left-leaning NDP opposition party that's propping up a minority Liberal government.

“When you’re the person that makes the interest-rate decision, you want to minimize the chance you make a mistake on the downside or the upside," Spence said. "You don’t want to over-tighten in an economy that’s extremely indebted.”

Canada's inverted yield curve is also a strong signal that investors see Macklem getting inflation back to target, Spence said. That confidence is more enduring than recent investor complaints that many of the Bank's eight rate moves over the past year defied market expectations, Spence suggested.

“It was very clear what the situation was, it wanted to send a signal that it was going to be serious about wrestling inflation to the ground," Spence said of the Bank's rate-setting panel. "There are times when you don’t want to surprise capital markets, but capital markets are only one interested constituency as far as the Bank is concerned, the general public and others are equally if not more important.”

MNI INTERVIEW: BOC To Slow Hiking Pace After 100BP Move- Ragan

MNI INTERVIEW: BOC To Slow Hiking Pace After 100BP Move- RaganSource: Bank of Canada