MNI INTERVIEW (RPT): Neutral BOC Rate For A Soft Landing-Poloz

(Repeats article first published on May 21)

Former Bank of Canada Governor Stephen Poloz told MNI Friday that lifting interest rates to neutral could be enough to curb inflation and price expectations without triggering a recession.

Higher global commodity prices and a "very tight" labor market create risks of more embedded inflation expectations that have to be dealt with, Poloz said in an interview Friday. “That has the ingredients to cause inflation to go up, and so therefore the normalization of interest rates would be intended to eliminate that excess demand, so that inflation no longer has this upward pressure.”

“I did say normalizing interest rates, which means getting them to neutral, but that’s kind of a wide range of possibilities anyway,” he said. The Bank recently said the neutral rate runs from 2% to 3%, and its benchmark overnight lending rate now stands at 1%. Many economists see 50bp hikes on June 1 and again in July.

“If nothing else is going on and you knew the neutral rate was let’s say 2.5%, you could just mechanically go to 2.5%," he said. "And then you’d have this question that you’re raising is: Would that be enough or do you have to go further?”

HIGHER RISK OF ERROR

Fed Chair Jerome Powell made a good case for the idea that tightening policy to remove excess demand such as high job vacancies should be enough, Poloz said. Markets “seem to believe we actually need a recession or close to a recession in order to cause inflation to go back down," he said.

"We don’t need one," Poloz said. "That doesn’t mean we wouldn’t have one by mistake or just because the oil price effect is bigger than most people give it credit for,” he said. “For one reason or another we could have one, but according to the models that I use, you don’t need to have one in order to get inflation to go back down.”

Inflation could slow to between 4% and 5% early next year and to around 3% later in 2023, but the interaction of all the forces pushing up prices elevates the danger, Poloz said.

“The risk of it continuing and maybe there being a mistake made is higher than it normally would be, because there are so many things we don’t know,” he said. “We don’t know if the movement in interest rates will have the same size of effect on the economy as it had five years ago or 10 years ago.” Higher energy and commodity prices also seem to be having less of an impact on boosting Canada's economy and its dollar than in past cycles.

CENTRAL BANKS MEAN BUSINESS

The good news is unless crude oil prices continually keep rising, some of today's high inflation will unwind due to base effects, and Canada could be very close to a peak in CPI, Poloz said.

“Symbolically that will be really important because inflation won’t be rising every month. Even if it’s high, people will say at least it’s heading down,” he said.

“You’ve got the central banks raising rates, which means they mean business, and you’ve got them doing QT, which shows twice that they mean business. So that combination of falling inflation and actions of the central banks ought to re-enforce expectations that one way or another we are heading back to 2%.”

After inflation subsides, it should also become clear that productivity has greatly improved through the pandemic as digitalization, flexible work habits and automation took hold, he said.