MNI INTERVIEW: BOC Must Remain Aggressive On Rate Hikes- Cross

Canada's central bank must remain aggressive with rate hikes and move at least another 75 basis points next month to prevent price inflation from feeding through to wage demands, a former top economist at the federal statistics office told MNI.

Philip Cross, former chief economic analyst at Statistics Canada and now senior fellow at the Macdonald-Laurier Institute, says Governor Tiff Macklem is still playing catch-up and every month of elevated price gains boosts the risk workers demand more too.

"The battle will really play out in wages," Cross said Wednesday. “What everybody is worried about at this point is, will this initial upturn in inflation trigger a wage price spiral?” (See: MNI INTERVIEW: Canada Faces Recession, Not Wage Spiral-Adviser)

“The Bank of Canada has to be aware that's still a distinct possibility and they're going to have to continue to crack down, to raise interest rates and slow down the economy,” Cross said.

FIGHTING THE CLOCK

Statistics Canada on Tuesday reported inflation slowed from a four-decade high of 8.1% to 7.6%. Cross agreed with investors who paid more attention to core rates that came in around 5%, well above the BOC's 2% target for headline price gains.

Canada needs "much higher interest rates to get core inflation back down to 2%," he said. "They still have a chance to realize their goal," at the central bank, he said, and "I personally hope they achieve it, but they're really fighting the clock."

The early slowdown "was probably the easy part" linked to gasoline and overheated real estate markets, Cross said. "Supply remains very constrained in this economy," and there are longer-term pressures around wages, services and some commodities, he said.

Those include China's tough Covid lockdowns hurting global distribution, food likely to remain expensive, natural gas prices rising as Europe seeks to displace Russian sources, and the potential for crude oil prices to jump again as the Ukraine war continues, he said.

SHRINKING LABOR FORCE

Closer to home Canada's job market remains tight with record low unemployment and record high job vacancies. More recently there have been several months of a contracting labor force, following the surge in participation as Covid lockdowns ended. With total output likely stuck in the short term "it's got to be very worrisome that the labor force continues to shrink," Cross said.

The Bank of Canada would be justified hiking its 2.5% overnight rate at least another 75 basis points at the Sept. 7 meeting according to Cross. The BOC moved a full percentage point in July, the biggest such move since 1998, saying it wanted to front-load tightening to avoid having to go even further in the future.

The September hike seen by Cross is a bit more aggressive than the economist consensus for a half-point move. While July's 100bp increase helped show the Bank is serious about inflation, Cross said, the job isn't done and "they don't have a lot longer to get that message out."

Governor Macklem has said the neutral interest rate is 2%-3% and he could meet the Bank's goals with hikes not too far beyond that. Cross said inflation pressures mean the Bank can't be too closely wedded to such an abstract concept.

STOP TALKING ABOUT NEUTRAL

“Frankly, I wish they would stop talking about neutral," Cross said. "Neutral is one of these things that we don't know and can't be measured. They can only be guessed at and frankly I don't think the Bank of Canada has a lot of credibility in its guesses these days.”

Interest rates must keep rising even if Canada faces a fairly "classic" recession, said Cross, who's also a member of a CD Howe Institute group that judges Canadian economic cycles. Demand has run too far ahead of production, the money supply surged as the Bank cut rates to around zero, and "this is why we have recessions," rather than any Covid overhang, he said.