MNI INTERVIEW: BOC Stays Restrictive Through 2024- Ex Adviser
Higher neutral rate and sticky inflation give the Bank little room to cut, Thorsten Koeppl says.
The Bank of Canada will remain in tight policy territory through this year with a resilient economy frustrating efforts to tame wage and price gains, former BOC adviser and Queen's University professor Thorsten Koeppl told MNI.
“They have a job to do, and the job is not over,” he said. “It’s great that they are holding off on the discussion of when to cut.”
Governor Tiff Macklem's 5% policy benchmark isn't very high relative to a nominal neutral rate that has potentially climbed into the range of 3.5% or perhaps even to 4.5%, he said. Officials need to keep a cushion above neutral to hold inflation down, he said.
That estimated neutral rate is higher than the Bank's view that it sits between 2% and 3%, something officials usually review in their April quarterly economic forecast. Koeppl says his views are those of a "hawk" at a time when investors see rate cuts around mid-year and perhaps starting as soon as April. Many investors also see rates tumbling through the second half of this year, something Koeppl also doubts.
SPREADING OUT THE PAIN
“I’m not timing the first cut, but I wouldn’t be surprised if by the end of 2024 we are still at quite a high interest rate,” he said. “They should be really hesitant to cut” similar to debates seen in other major economies, said Koeppl, who has also done research for the ECB, the New York Fed and the RBNZ.
The Bank's 10 rate hikes have throttled back the economy so further tightening isn’t needed, he said, even with GDP still outpacing some Bank forecasts. “We’ve been choking off the economy already, maybe it’s more spread out, which explains why we have this more soft landing now.” (See: MNI: Canada Seen As Resilient To Rate Hikes- Finance Memo)
Monetary policy also needs to lean against faster government spending, Koeppl said. Justin Trudeau's Liberal minority government must call an election by fall 2025 under a traditional four-year mandate, and the NDP that's propping him up is demanding a new public health care program in the next several weeks or they will end a "supply and confidence" agreement.
Macklem told lawmakers last week a rush of spending across governments could make his job harder, and has previously said fiscal and monetary policy appeared to be rowing in different directions. The federal government's latest monthly fiscal report showed program spending up 6.3% from a year ago, much faster than the Bank's 2% estimate of potential growth.
DANGEROUS INFLATION EXPECTATIONS
“Fiscal policy hasn’t really pulled along with monetary policy and I think that should give pause to the Bank,” Koeppl said.
It's not just governments outrunning fundamentals shaping inflation according to Koeppl. Stagnant worker productivity remains at odds with wages rising at a 5% clip, well above the Bank's 2% inflation target, and he said a recent wave of labor strikes suggest that pressure will continue.
Cutting borrowing costs too soon also carries risk of a U-turn later that would damage a central bank whose monetary framework is already under the most significant attacks since inflation targeting was adopted in the early 1990s, he said. Some observers have suggested that even with core inflation at 3.5% the Bank can ease up with headline prices settling around 3%.
“That would be dangerous, mostly for inflation expectations,” Koeppl said. (See: MNI: Canadians Doubt BOC Wins Inflation Fight-Internal Polls)