MNI INTERVIEW: BOC Hike More Likely Near-Term Risk: McNeil

The Bank of Canada is more likely to raise interest rates again to handle sticky inflation rather than tilt to investors betting on a cut according to James McNeil, co-author of a recent paper with former advisers who also did PhD research at the central bank.

“I see more upside risk I think than some other people, and also just recognize that while inflation has fallen we’re still well above the 2% target,” said McNeil, an assistant economics professor at Dalhousie University in Halifax, Nova Scotia. “I wouldn’t be surprised to see them raise further.”

Wage gains in the service industry are one of those upside risks according to McNeil. Service worker pay is a big driver of inflation in a big part of the economy still being stretched as things returns to normal after Covid, he said. Central bankers must ensure they break any emerging wage-price spiral he said, pointing to a recent public union strike with pay demands well above the Bank's 2% target.

Governor Tiff Macklem's pause at 4.5% in March means Canada may also get too far out of step with the Fed and ECB tightening, McNeil said. The main problem would be weakness in Canada's dollar that drives up import prices, he said.

"It’s kind of hard to see how long that can go on for without the Canadian dollar taking a bit of a hit," he said. "As the Fed and the ECB continue to raise rates that might force the Bank of Canada’s hand to potentially push a little bit higher.”

MANAGING A SOFT LANDING

Canada's inflation slowed to 4.3% in March from a peak of 8.1% last June that was not quite as high as the levels U.S. CPI reached. That's one reason Bank officials have said they can pause. (See: MNI INTERVIEW: BOC Has Done Enough To Slow Inflation-CD Howe)

The next few months bring important updates on the drag of eight rate hikes through January on households renewing mortgages, McNeil said. So far there is little direct connection between recent U.S. bank failures and Canada that require looser policy, especially with officials seeking to slow demand, he said.

“It’s unclear whether or not conventional monetary policy is the right tool to respond to that" U.S. market turmoil, McNeil said.

While wage gains are troublesome for inflation they show Canada is resilient to rate increases and the economy may skirt a recession, he said. McNeil suggested the Bank's single inflation mandate still means officials will cool things as needed to restore price stability.

“The good news is labor markets have held up better than I think most people anticipated, so there is still some possibility of managing that soft landing,” he said.

POLICY BLUNTED BY TWISTS

Whenever the next recession is, the Bank's tools aren't as powerful as they were decades ago when interest rates were higher, according to a paper he wrote with Thorsten Koeppl and Jeremy Kronick. Looking across the whole yield curve they found monetary policy from 1996-2020 was sometimes blunted because the curve twisted, meaning for example rates could rise at the short end and decline at the long end after a policy change.

Emergency tools used during the Covid shocks like QE and forward guidance weren't as powerful as could have been hoped for either, McNeil said. Promising to keep interest rates near zero was conditional and may have tempered things, he said.

“If you make an explicit commitment and then you’re wrong about where the economy is going to go in the future… then it’s hard to back away from that,” he said. “That makes it hard to really move financial markets a lot.”

Asked about investors who have bet on a rate cut this year, he said “It’s too early in my view to be forecasting a decline.”