MNI INTERVIEW:BOC Set For Another 50BPs at June Meet-Ex Fellow

The Bank of Canada is setting the stage for another 50bp interest-rate hike at its next meeting on June 1 and perhaps another aggressive option of lifting borrowing costs beyond neutral, former central bank research fellow Michael Devereux told MNI.

Stronger-than-expected growth coming out of Covid, a tight job market and global prices boosted by the Ukraine conflict likely require a more forceful response, he said in a phone interview Wednesday. Devereux teaches at University of British Columbia and is on the CD Howe Institute's shadow monetary policy council, and he spoke after Governor Tiff Macklem hiked rates half a point to 1%, the first 50bp move since 2000.

"Interest rates are going up, but we haven't seen the high point in inflation yet" and it may not fade in the next six months, he said. "There's also a big communications problem: I mean people will see the Bank raising interest rates, tightening over the next year, but then inflation increasing. So the Bank has to convince people that they're on the right track, that inflation over the medium term is going to decline."

The Bank raised its forecast to show inflation averaging about 6% over the first half of the year, triple its 2% target, and said CPI won't return to that mark until 2024. Governor Macklem said he can be forceful if needed to brake inflation and said rates could end up higher or lower than the 2.5% neutral rate depending how the economy evolves.

AVOID OVER-TIGHTENING

Hiking to neutral "is in the situation where inflation is on target, and inflation is well above target now, so one could make a case that they'd have to raise the rate above the neutral rate in order to reduce inflationary pressures," said Devereux. "But they're on a real tightrope because we don't want to precipitate a recession."

"If we can get inflation moving downwards towards the end of the year, if we end up with maybe 4.5% year-on-year and then further down towards 2% at the end of 2023, I think that would be consistent with a successful soft landing."

Macklem told reporters “we’re not on autopilot, we’re not headed to some pre-set destination on interest rates,” and “we will be assessing how the economy is responding” to higher rates. One of the big concerns is heavily indebted consumers pulling back to cover higher mortgage costs.

"The good thing is that the Bank has a 30-year history of inflation targeting; they've kept inflation at a 2% average since 1990 despite lots of shocks," Devereux said. "So they have a very good track record."

"The hope would be is that this spike in energy and food prices is relatively temporary and will ease off as we move on through this year. If it doesn't, of course, then it's very hard to see how the Bank can easily get down to target without dramatically raising interest rates, which they certainly don't want to do."

The pressure is building, with the Bank's forecasts showing even core rates well above target and a large majority of CPI components rising faster than 3%.

Source: BOC