MNI INTERVIEW:Poloz Sees Conditions For Rates Easing Next Year
Former BOC Governor says markets may do advance work for central banks if inflation keeps cooling.
Former Bank of Canada Governor Stephen Poloz believes borrowing costs are likely to fall next year, though a reduction in bond yields would precede any official monetary easing as the BOC and other central banks remain cautious about ensuring price expectations have been tamed, he told MNI.
Two thirds of Canada's inflation reports over the last year have lagged market expectations and that trend is set to continue amid weaker consumer spending and a challenging job market, he said in an interview. There's growing evidence the economy is moving into choppy waters if not technical recession, Poloz said.
“It’s going to be the bond market that would do the work for us, it doesn’t need to be the central bank that wakes up in the morning and decides oh, it’s time to cut rates,” said Poloz, now a special advisor at the Osler, Hoskin & Harcourt law firm after leaving the BOC in 2020. “What we’ll see is bonds rallying around this data flow, and at certain points central banks will see the numbers for what they are and will say it looks like we’ve done the job and then they will begin to lower rates, but I don’t know the timing.”
Central bankers still need more assurance inflation expectations are well anchored, he said.
“Most people just go to the store and see higher prices, and so through all that are they supposed to figure out that inflation expectations really still should be 2%?” Poloz said. “What runs the risk of de-anchoring expectations is the extra five points of inflation that came from Putin’s invasion, and the risk that infects core bits of our inflation.”
Central bankers seeking calmer inflation expectations “need proof of that, and that’s perfectly natural. When there’s this much fog it’s easy to make a mistake,” said Poloz, who led the BOC for seven years through the early part of the pandemic slump.
Forecasters are at risk of being misled by supply shocks through the pandemic and Russia's invasion of Ukraine, he said. Rather than a typical cycle where more hiring and output can stoke inflation, Poloz said this one appears to be led by firms rebuilding lost production that can slow prices even as the economy moves ahead.
Current Governor Tiff Macklem held rates at the highest since 2001 earlier this month at 5% and said he's prepared to tighten again. The Bank sees inflation above its 2% target until mid-2025, and investors recently have come more to the view Macklem will hike again on Oct 25, with no cuts until perhaps mid-2024.
“In this environment we’re in the risk of us slipping into a longer period of above-target inflation, that risk is pretty high, and the way to manage that risk is for central banks to be tighter than they would be,” Poloz said. (See MNI INTERVIEW: BOC Needs Hawkish Footing - Ex Deputy Minister)
The Bank paused and then resumed hiking earlier this year as consumer spending showed unexpected resilience. But it's becoming clearer that a downward trend is taking hold, Poloz said. “It looks to me like we’re in a sort of consumer recession, and if we’re not we will be, because each month that goes by, more people that have to renew their mortgage and so definitely have constraints."
WAGE GAINS OVERSTATED
“As we go into the new year, we should see increasing evidence of this” type of slowdown, he said. (See: MNI INTERVIEW: BOC Seen On Hold Until Mid-2024 Cut- Stillo)
“There are pockets of serious weakness in the economy and still pockets of strength, and when we look at it, it’s a mug’s game to decide whether we’ll have a measured recession or a soft landing or any of those things," he said. "We know that there’s lots of stress out there too, and it goes to companies too.”
While wage gains running around 5% are something to watch, Poloz said those increases are overstated by at least a percentage point, citing evidence of firms hiring extra managers as older workers prepare for retirement. The Bank's QT policy should also exert a drag on inflation just as QE amplified Bank stimulus, he said.
Conditions for lower borrowing costs "certainly" can come along in 2024, Poloz said, but there are still too many moving parts to provide much certainty around timing.
“Just because the economy is slowing it won’t be time to say we’re all done because that residual force of inflation will still be percolating. And we see labor militancy at a pretty high level right now, so we have a lot of ingredients of inflation risk.”