Bank of Canada’s policy-makers split on need for further rate hikes

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The Bank of Canada’s policy-setting Governing Council is divided on whether more interest-rate increases may be needed to bring inflation back under control, according to a summary of the discussions that took place ahead of the central bank’s latest rate decision.

The bank held its policy rate steady at 5 per cent on Oct. 25 for the second rate announcement in a row, but warned that it could hike again.

The summary of deliberations, published Wednesday, shows Governor Tiff Macklem and the bank’s five deputy governors remain concerned that high inflation is becoming entrenched, with some unsure whether they’ve tightened monetary policy enough.

“Some members felt that it was more likely than not that the policy rate would need to increase further to return inflation to target. Others viewed the most likely scenario as one where a 5-per-cent policy rate would be sufficient to get inflation back to the 2-per-cent target, provided it was maintained at that level for long enough,” the summary said.

There was a “strong consensus” that the bank should be patient and keep rates steady for now, then “revisit the need for a higher policy rate at future decisions with the benefit of more information.” The bank has raised interest rates 10 times since March, 2022.

The rare public split among senior policy makers highlights the challenge the Bank of Canada faces amid conflicting economic signals.

Economic growth has stalled in recent months as higher borrowing costs have squeezed households and businesses. Consumer spending has been weaker than the central bank expected, and household credit growth has declined substantially. Over all, supply and demand in the economy is “approaching balance,” the summary said, which should pull inflation down over time.

There’s dissent at the Bank of Canada, and the fact we know about it is progress

At the same time, inflation remains nearly twice the bank’s target, with annual growth in the consumer price index clocking in at 3.8 per cent in September. Two weeks ago, the bank raised its inflation forecast. It now thinks inflation will remain around 3.5 per cent for the next year, with risks skewed to the upside.

Some of this revision is tied to higher oil prices. However, the Governing Council is more worried about measures of core inflation, which strip out volatile components of the CPI, such as food and energy. Most core-inflation measures have remained stuck between 3.5 per cent and 4 per cent for the past year. The summary said this lack of downward momentum “was a source of considerable concern.”

“As excess demand continues to be absorbed, persistence in core inflation, elevated inflation expectations and wage growth, and atypical corporate pricing behaviour could be indications of high inflation becoming entrenched. In such a scenario, members acknowledged that further monetary policy tightening would likely be required to restore price stability,” the summary said.

The bank only began publishing roundups of its policy-setting discussions in February of this year, on the recommendation of the International Monetary Fund. The bank was a laggard compared with peers on this aspect of transparency. Many other central banks, including the U.S. Federal Reserve, have long published detailed minutes of their policy debates.

It’s unclear which members of the Governing Council are hawkish about the possibility of further rate hikes, and whether that group includes Mr. Macklem, who holds ultimate decision-making power.

“Unlike in the U.S., governing council members do not voice individual opinions in speeches. Instead, they speak on behalf of the group,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients.

“What is clear is that there’s a faction that could begin pushing for further tightening should the economy and inflation not co-operate,” he wrote.

The bank emphasized the rising price of shelter as a key factor getting in the way of disinflation. Higher interest rates have pushed mortgage service costs much higher, but this hasn’t brought down home prices or slowed the pace of rent increases as much as the central bank would have expected.

“The ongoing structural shortage of housing supply in the economy was sustaining elevated house prices. And the rapid increase in Canada’s population had added to the existing imbalance between demand and supply for housing,” the summary noted.

The summary also flagged risks that government spending could make the central bank’s job harder. Aggregate spending plans for federal and provincial governments are projected to increase at an annual pace of around 2.5 per cent next year.

“If all those plans are realized, this would contribute materially to growth over the next year. By adding to demand at a faster pace than the growth of supply, government spending could get in the way of returning inflation to target,” the summary said.

The Bank of Canada’s next rate decision is on Dec. 6. Most Bay Street economists think the bank is finished tightening monetary policy. However, Toronto Dominion Bank rate strategists Andrew Kelvin and Robert Both warned against being too complacent about the possibility of another rate hike, in light of the central bank’s hawkish communications.

“The BoC has every incentive to talk tough here in order to maximize the impact of the tightening currently in place, so it’s difficult to distinguish between posturing and genuine signals of intent,” Mr. Kelvin and Mr. Both wrote in a note to clients about the summary of deliberations.

“At the same time, it would be reckless to completely dismiss the BoC’s warnings out of hand.”