ANALYSIS: BoC Leaves Door Open for More Rate Hikes as Economy Slows

Econ prof says BoC aiming to maintain credibility in pressuring inflation lower

ANALYSIS: BoC Leaves Door Open for More Rate Hikes as Economy Slows
Bank of Canada governor Tiff Macklem holds a press conference at the Bank of Canada in Ottawa on July 12, 2023. (The Canadian Press/Sean Kilpatrick)
Rahul Vaidyanath

OTTAWA— The Bank of Canada has come under political pressure to stop hiking rates as the economy cools. The central bank held its key policy rate at 5 percent on Sept. 6 but said it’s “prepared to increase the policy rate further if needed,” as it remains concerned about inflation persisting.

Bay Street economists say the current overnight rate target of 5 percent will likely be as high as the BoC goes. Professor emeritus of economics Steve Ambler at Université du Québec à Montréal says the BoC has to maintain its credibility that it’s tough on inflation while also watching how the economy evolves.

“I think it lost some of its credibility when it started raising rates too late, and I think they're really worried that, unless they maintain their credibility, that inflation is going to take longer to beat,” he said in a Sept. 6 interview.

BMO chief economist Doug Porter noted the “hawkish” nature of the central bank’s statement.

“Policy-makers clearly do not want a repeat of earlier this year, when a short-lived pause sparked thoughts of eventual rate cuts, in turn firing up housing,” he said in a note.

“Unless growth rebounds in Q3—which we doubt—the BoC is likely done with rate hikes,” Mr. Porter added.

CIBC chief economist Avery Shenfeld also said he thinks 5 percent is as high as interest rates need to go to get inflation back to its 2 percent target.

RBC assistant chief economist Nathan Janzen said he expects the BoC to hold rates where they are through the end of the year.

Forecasting the Consumer

A vital data point was the second quarter’s negative economic growth of -0.2 percent on an annualized basis, which came in far below the BoC’s July estimate of 1.5 percent

The contraction in gross domestic product (GDP) was due to a slowdown in consumer spending, declines in home building, and more imports than exports.

That marks two straight quarters that the BoC has missed badly on its quarterly growth forecasts—largely due to consumer spending. In July, the central bank said Canada’s economy was stronger than expected in the first quarter—thanks to consumer spending—which suggested persistent excess demand in the economy.

Consumer spending is a significant component of GDP. At the start of the pandemic, households couldn’t spend what they wanted to and many just saved the government support they received.

Mr. Ambler has long been critical of how the BoC fails to factor money supply into its monetary policy, which he says could help in forecasting consumer spending. 

“The Bank of Canada, as you know, pays no attention whatsoever to money [supply]. That might help them, that might inform what's going on with consumption a little bit if they were to pay some attention to it,” he said.

Certain measures of the money supply in the economy started growing by more than 20 percent per year at the start of the pandemic, but now those measures are shrinking by close to 10 percent a year.

Mortgage Costs Drive Inflation

Inflation ticked up in July by 0.5 percentage points to 3.3 percent. In comparison, G7 inflation was 3.9 percent in July year over year, the Organisation for Economic Co-operation and Development reported on Sept. 5.

The BoC expects higher gas prices to keep inflation elevated in the near term before it comes down. It reported that core inflation measures are still running at around 3.5 percent.

Mortgage interest payments, rising at over 30 percent a year, continue to be the biggest contributing factor to above-target inflation.

CIBC’s Mr. Shenfeld says he believes the BoC is “not a fan” of examining headline inflation without this rapidly increasing component.

“While MIC [mortgage interest costs] is a big factor in these trends, the bank must feel that if not for that pressure from higher mortgage payments, household spending power would be pushing inflation in other components at a faster pace,” he said in a Sept. 6 note.

After B.C. Premier David Eby wrote to BoC Governor Tiff Macklem on Aug. 31 calling for a halt to rate hikes, Ontario Premier Doug Ford joined the call with a letter on Sept. 3, saying it is making it “next to impossible” for young people to buy a home. 

Mr. Ford also noted that banks are expecting a spike in defaults on loans and mortgages as people struggle to pay the high cost of interest.


“The Canadian economy has entered a period of weaker growth, which is needed to relieve price pressures,” the bank said.

Canada’s economy may be amid a technical recession—two straight quarters of negative economic growth—depending on how the third quarter ends up. 

The BoC forecast 1.5 percent growth in Q3 in July, but that appears optimistic now given Statistics Canada’s early read on July.

But economists tend to be less rigid about what constitutes a recession, and Mr. Ambler says he’d call a recession an event where economic slowdown is spread across various sectors.

“Unemployment has been ticking up, but it's still fairly low by historical standards,” he points out.

The central bank noted also that Canada was not immune to slowing economic growth in the second quarter. It stated that growth slowed globally in the second quarter “largely reflecting a significant deceleration in China,” and that “growth prospects in China have diminished.”

But the BoC noted that United States growth was stronger than expected due to consumer spending, which is in contrast to the Canadian situation.

Rahul Vaidyanath is a journalist with The Epoch Times in Ottawa. His areas of expertise include the economy, financial markets, China, and national defence and security. He has worked for the Bank of Canada, Canada Mortgage and Housing Corp., and investment banks in Toronto, New York, and Los Angeles.
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