MNI INTERVIEW: BOC To Follow Through Even If Recession- Tombe

The Bank of Canada will follow through on its commitment to keep monetary policy tight until inflation comes back to its target range even if that triggers a recession, Trevor Tombe, a University of Calgary professor doing academic research with central bank staff, told MNI.

The exact path of higher rates depends on uncertain developments around global commodity prices and the Ukraine war, Tombe said. Canada's dual role as a major energy exporter and consumer makes the mix even more complicated, he said.

Governor Tiff Macklem hiked a full percentage point in July and another 75bps to 3.25% on Sept. 7, leading G7 central banks in tightening this year. While economists see a 50bp increase at the Oct. 26 meeting and a 25bp move in December, several predict a cut next year as growth falters. But policy makers only see inflation returning to around the top of their 1%-3% target range at the end of 2023, with Tombe stressing that the BOC’s determination to meet its prices mandate should not be underestimated.

“They have quite clearly signaled that they will keep the tightening going until inflation is back to their target range, and there’s every reason to think they are serious about that,” Tombe said. While not making his own prediction, he pointed to one-year note yields of around 4% on Monday as a sign of where things could be headed, noting the yield implies some time with the Bank's rate above 4%.

MORE PAIN THAN USUAL

The Bank is under a bigger obligation to react to signs of persistent inflation, Tombe said. Price gains are also being driven mostly by supply-side factors according to his recent research, so monetary policy will have to inflict more pain than a cycle powered by demand.

"If their rate increases do cause a recession, well so be it, because that isn’t their mandate to ensure output doesn’t shrink," he said. “If it does lead to a recession it may be a modest one,” he added, saying that a slowdown could come without boosting unemployment as firms cancel job vacancies.

The balance between taming inflation and avoiding a recession has divided experts. Former governor David Dodge told MNI last week that he would opt for 100bps of rate hikes over the next two meetings, while a former central bank scholar said policymakers have already hiked too much. (See: MNI INTERVIEW: BOC Can Hike 100 In Next 2 Meets- Ex-Gov Dodge)

Governor Macklem on Monday took the unusual step of posting a Twitter video telling Canadians the pain of higher interest rates will pay off as the pace of increase in the cost of living returns to normal.

Tombe's view of the need for more action follows reports showing CPI inflation fading to 7% from a four-decade high of 8.1%. The Bank over time will get inflation under control, he said, with most of the power of recent rate hikes being felt next year.

“It is more costly to lower inflation when it is supply driven than when it is demand driven, but monetary policy can still be effective in either case,” he said. “Over the medium term I do think the central bank’s actions will be effective."