Bank of Canada Governor Tiff Macklem said borrowing costs may now be “restrictive enough” to get inflation under control, his most explicit comments to date suggesting that interest rates have peaked.
Speaking to the Saint John Region Chamber of Commerce on Wednesday, Mr. Macklem said that tight monetary policy is working to cool demand in the economy and that the central bank expects economic activity in Canada to be weak for the next few quarters.
That “means more downward pressure on inflation is in the pipeline,” he said in his first speech since holding the bank’s policy rate steady on Oct. 25. “In short, the excess demand in the economy that made it too easy to raise prices is now gone.”
Mr. Macklem did not rule out further rate hikes if inflation proves more stubborn than expected, and said that the bank needs to “stay the course.” But his remarks seemed to reinforce market and analyst expectations that the central bank is done tightening monetary policy, and that the key question now is when the bank will begin cutting rates.
A day earlier, Statistics Canada reported a significant drop in inflation. Annual Consumer Price Index growth declined to 3.1 per cent in October from 3.8 per cent in September. That puts the inflation rate only slightly above the upper end of the Bank of Canada’s inflation control band of 1 per cent to 3 per cent. It formally targets 2-per-cent inflation.
In a press conference after the speech, Mr. Macklem was asked whether the federal government’s fall economic statement, published Tuesday, would help or hinder the bank’s fight with inflation. He had previously said that monetary policy and fiscal policy were not “rowing” in the same direction.
“From the perspective of monetary policy, the fall economic statement suggests that the government is not adding new or additional inflationary pressures over the next couple of years, which is the critical period over which we will be looking to reduce inflation and get it back to the target,” Mr. Macklem said.
He added that the government’s new commitment to keep budget deficits under 1 per cent of gross domestic product, starting in the 2026-27 fiscal year, is “helpful.”
The fall economic statement showed Ottawa’s deficit for the current fiscal year was essentially unchanged since the spring budget, despite the government announcing an additional $20.4-billion in spending over the next six years. Expected deficits in the next few years were revised up by an average of $7-billion, although this mostly reflects higher debt-servicing costs and slower revenue growth.
The bank has raised interest rates 10 times since March, 2022, to deal with inflation, lifting its policy rate from 0.25 per cent to 5 per cent, the highest level in more than two decades. Mr. Macklem and his team have left rates unchanged for the past two interest-rate decisions. The next rate announcement is on Dec. 6.
Most private-sector economists believe that the Bank of Canada has finished tightening monetary policy. Many are betting it will start lowering rates around the middle of next year.
“The confirmation that the governor believes that rates are high enough to return inflation to 2 per cent is clearly dovish,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients about the speech.
“Our view is that further economic weakness will be seen over the remainder of this year and early in 2024.” he wrote. “That will be enough to prompt rate cuts in the second quarter of 2024.”
Growth in Canada’s gross domestic product has essentially flatlined since the spring, and the unemployment rate has moved up to 5.7 per cent from a low of 4.9 per cent last year. Statistics Canada will publish third-quarter GDP numbers next week.
Mr. Macklem said it’s too early to be talking about rate cuts. But he said the bank could start lowering rates before inflation reaches 2 per cent. That’s because monetary policy is forward-looking, and interest-rate changes take many quarters to have an impact.
Before contemplating rate cuts, the bank will need to see a sustained decline in core-inflation measures, which strip out the most volatile price movements, Mr. Macklem said. He noted that core inflation moved lower in October, but that “one month is not a trend.” The bank is also looking to see a fall in short-term inflation expectations and a slowdown in wage growth.
Much of the speech focused on the pain of high inflation, and why Canadians have such a grim view of the economy despite a strong labour market.
“People are working hard, but their salaries don’t buy what they used to. They can’t afford the things they need to live. It feels unfair. That feeling of unfairness eats away at the fabric of society,” he said.
This happened in the high-inflation period of the 1970s. At that time, it took much higher interest rates than today, and a painful recession, to break the back of inflation. Mr. Macklem said he was hopeful that this won’t be necessary today. The central bank acted more forcefully this time around, he said, and inflation expectations remain better anchored than in the 1970s.