MNI INTERVIEW: Deficit Means Little Scope For BOC Cut- Asselin

The Bank of Canada has little scope to cut interest rates amid inflation uncertainty and continued fiscal stimulus, former adviser to the prime minister and finance minister Robert Asselin told MNI.

“Central banks are a bit in a bind in the sense that for their own credibility they need to keep financial markets and market participants really believing that they are tightening,” says Asselin, now policy adviser for the Business Council of Canada that represents many of nation's largest companies. “I wouldn’t fight central banks on this.”

Some investors predict even if policymakers hike another quarter point Jan. 25 they will end up cutting late this year with the economy sinking into recession. After the BOC misread turning points that drove inflation towards 8%, Asselin sees Governor Tiff Macklem erring on the side of caution about loosening afterwards.

"You can sense there’s an uncertainty in the forecast in how they predict inflation and how soon can they really lock the rates before they will eventually go down if there’s a recession,” Asselin said on MNI's FedSpeak podcast.

The job market is also still at nearly full employment levels, Asselin also noted. That's after seven rate hikes last year totaling 4 percentage points, one of the fastest tightening campaigns since the Second World War.

UNHELPFUL FISCAL POLICY

Government spending remains elevated even after unwinding Covid relief programs according to Asselin, who advised Bill Morneau who brought many of them in when he was finance minister. “It’s not helping necessarily on the inflation side,” Asselin said.

“In a scenario where historically it’s been so difficult to bring down inflation, at the level that it is now, a soft landing will be very difficult to engineer," he said. His comments mirror those of others who say fiscal policy is undercutting the Bank and Macklem will need to do more. (See: MNI INTERVIEW: Canada Still Lacking Fiscal Restraint-Ex Deputy)

The "fiscal anchor" touted by current finance chief Chrystia Freeland -- lowering debt as a percentage of GDP each year-- is fairly weak, Asselin said. The government doesn't appear to be moving to adopt a tougher one such as capping interest payments as a share of outlays, he said.

While Asselin welcomed the prospect of this year's budget spending more on industrial benefits in response to the U.S. Inflation Reduction Act, there's a risk the expenditures will be unfocused. “Canada needs to think about its own competitiveness more seriously,” he said. That includes focusing on clean energy, value-added agriculture and making sure record immigration allows new workers to use all their skills.

Such changes are needed amid geopolitical tensions that bring more global inflation and force Canadian firms to rework supply chains, Asselin said.

“There is a consensus that rates will stay higher, longer, to control inflation” Asselin said. “We need to be very humble in predicting the near future.”