MNI INTERVIEW: BOC Needs Bold Hike Beyond Neutral-Senator

The Bank of Canada could take "bold" action to raise its interest rates above neutral levels in order to bring inflation back to target in the G7's most over-heating economy, Senate Banking Committee member and former finance department adviser Clement Gignac told MNI.

“It’s not too late to restore credibility, so maybe we will see a bold move from them,” Gignac said, pointing to a similar shifts underway at the Fed and ECB. His comments came as Governor Tiff Macklem has said he could be more forceful after back-to-back 50bp hikes to 1.5%, a sign the BOC could move by 75bps at its July 13 meeting. The Fed on Wednesday hiked 75bps to a range of 1.5%-1.75%, with policymakers projecting the rate could end the year at 3.4%.

Canada's benchmark may reach 3.5% according to Gignac, taking it past Macklem's view of a neutral rate lying between 2% and 3%. Macklem has said dangers from broader inflation pressures and embedded expectations make it more likely he will move to neutral or beyond, though he hasn't laid out exact conditions for restrictive policy.

The case for going beyond neutral is stronger in Canada than the U.S., though in both cases credibility is at stake after missing early signs of a price build-up, Gignac said.

“I put a significant probability that at some point the Bank of Canada overnight rate will exceed the Fed funds because we have a higher labor participation rate, we have higher GDP growth expected, so I think the Bank of Canada has a high probability to be forced to go above neutral,” he said.

COLLATERAL DAMAGE RECESSIONS

“Canadian households will be better able to live with interest rate increases in my view than the U.S.,” thanks to a tougher stress test on mortgage loan candidates, he added.

Gignac pointed to OECD forecasts showing Canada will lead GDP growth within the G7 this year with 3.8% expansion versus 2.5% for the U.S. This growth comes from an economy that has already moved above full output, he said.

Higher rates boost the risk of recessions in Canada and the U.S. but that is "collateral damage" when weighed against core mandates to maintain price stability, he said. “If any recession occurs, it will be short and less severe than 2008 or in the 70s experience,” he said.

Central bankers have also gone off track with recent talk emphasizing inclusive economies over price stability, Gignac said. “That's the weakness here: Central banks talk about inclusiveness, recovery, this isn’t exactly their job."

FRONT-LOADED MESSAGE NEEDED

While policymakers can be blamed for missing early signs that prices were taking off, big drivers such as the Ukraine war could not have been foreseen, he said. “Better to be front-loaded” and to “return as soon as possible to neutral monetary policy,” said Gignac.

“It’s better for central banks, they have to restore their credibility, and send a signal loud and clear, they have no intention to let inflation expectations accelerate,” he said. Former BOC adviser Randall Morck has also warned of a hard landing.

The BOC hasn't hiked by 75bps since 1998 when the policy rate rose a full percentage point in a failed bid to shore up a sagging Canadian dollar. Former BOC research award winner Francisco Ruge-Murcia has also told MNI Macklem may need to go beyond neutral to bring inflation back to the 2% target.

FISCAL POLICY PULLBACK

Gignac, a former Quebec economic development minister who later overlapped with Macklem at the federal finance department, said fiscal policy must also pull back. Recession risk means that can't happen right away, he said, expressing a less aggressive view than a former top official who told MNI policies should be symmetrical in exiting stimulus. (See MNI: Canada Should End Stimulus Symmetrically- Ex Cabinet Czar)

“It’s very important that governments do not stimulate further, because you would just contribute to the problem of inflation,” Gignac said. “It’s very important that fiscal policy adopt an exit strategy, adopt anchors.”

As for a Conservative leadership candidate's call for Macklem to be fired, Gignac warned that such a move could backfire, triggering a currency plunge and driving up prices further.