MNI INTERVIEW: BOC Nearly Done Hiking On Stall Risk-Ex Adviser

Canada's central bank is nearly done hiking rates and will lag the Fed to avoid the danger that over-tightening will drag the economy into recession under the weight of high consumer debts, former adviser Angelo Melino told MNI.

Governor Tiff Macklem could stop after a quarter-point hike to 4% at the next meeting or perhaps at 4.25%, leaving it well short of some forecasts for the Fed to go to 5%, Melino said. The Bank of Canada on Wednesday hiked 50bps instead of the 75 most economists predicted.

“There has been a lot of tightening that has been in the system already and is working its way through,” said Melino, a Bank adviser around the 2008 global financial crisis. “There’s a high chance that they over-do it.”

The BOC has raised its overnight rate 350bps since March, the strongest such action since adopting fixed announcement dates in 2000. Inflation jumped to a four-decade high of 8.1% as services re-opened following Covid lockdowns and the Ukraine war drove up commodity prices, moderating to 6.9% in September. The Bank says CPI won't return to the 2% target until the end of 2024 even with a 50-50 chance of a technical recession by the middle of next year.

Macklem did the right thing Wednesday by stepping down to a 50bp hike from September's 75bp and July's 100bps, Melino said, a decision that caused a plunge in bond yields. The Bank is likely to hike another 25bps in December, though if inflation remains a big problem it could tighten by 50bps, he said.

FEELING FOR THE EDGE

“It’s this thing where you are feeling for the edge rather than running towards it, so I’m glad they went 50, they didn’t go the full 75,” said Melino. “They can wait six more weeks and they can certainly raise 50 again if they decide that they need to.”

The Bank is likely sticking to the dovish end of further action because it's aware of how the cumulative effect from worldwide rate hikes may hit Canada's commodity-export economy, he said.

“They have done a lot and this stuff takes a while to work its way through the economy, so at one point you have to slow down and look around,” he said. "Coordinated tightening is probably going to have a bigger impact on global growth than they thought before, that will matter for our exports... I think that gives us a little bit of caution.”

Some former advisers have told MNI that even a recession won’t deter the Bank because of the overriding need to pull inflation back to a 2% target, a view that's drawn criticism from the NDP party that's propping up a Liberal minority government. (See: BOC To Follow Through Even If Recession- Tombe)

THE FOUR CAMP

“If we get a recession late this year, early next year, it will be brought on by monetary policy tightening in Canada and around the world, maybe an external geopolitical event,” said Melino, who's also part of a recession-dating panel convened by the CD Howe Institute.

The Bank has yet to face the most difficult phase of restoring price stability, Melino said, driving inflation the last distance back to 2%. While goods prices will likely flatten out soon as supply chains heal, services are the wild card because monetary policy has little sway there.

“Getting down halfway is the easy part, it’s the last two or three percent, going down from five to two, that’s going to be the most difficult to achieve,” Melino said. “The question will be how much services inflation we’re going to have to put up with.”

But Canadians strained by higher prices are also carrying debts that have ballooned to more than the country's GDP, leaving Macklem less scope for hikes. “I’m in the camp that they will go to about four, maybe four and a quarter, but I don’t expect they’ll go much higher,” Melino said. “I don’t see Canada’s interest rate tracking anything quite that high” as the view the Fed may go to 5%, he said, “because of our high debt levels.”