Canadians should not expect interest rates to fall back to very low levels seen over the past decade, Bank of Canada Governor Tiff Macklem said on Thursday.
Speaking at a news conference, Mr. Macklem warned that the era of historically low borrowing costs that followed the 2008-09 financial crisis is a thing of the past. The surge in inflation over the past two years, followed by the central bank’s recent rate-hike campaign, have put the economy on a path on which borrowing costs will be persistently higher.
“Nobody should expect that interest rates are going to go back down to the very low levels that we’ve seen over the last decade or so,” Mr. Macklem told reporters following the release of the central bank’s annual Financial System Review.
“We’re in a transition period to a world where interest rates are going to be higher than what many people have gotten used to,” he added. “That transition is going to take a while. And through that transition, that creates some risks.”
Mr. Macklem refrained from commenting on the short-term outlook for interest rates, which has been thrown into question over the past few weeks by stronger-than-expected inflation and employment data. But his comments on the longer-term outlook for rates suggest the central bank is girding itself for a drawn-out fight with inflation and an economy in which consumer prices are more volatile than before.
At 4.5 per cent, the central bank’s benchmark interest rate is the highest it has been since 2007. It won’t remain at this level forever; as the economy slows and inflation falls to normal levels, the bank will eventually cut rates. A severe recession (which is not the bank’s base-case scenario) could even force the bank to chop rates quickly.
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Nonetheless, mortgage holders and would-be home buyers shouldn’t count on the near-zero interest rates seen in the first two years of the COVID-19 pandemic or in the years following the financial crisis.
Mr. Macklem isn’t alone in this prediction. A number of other central bank chiefs have suggested over the past year that interest rates could be higher going forward due to structural changes in the global economy. The process of globalization, which has put downward pressure on consumer prices, is stalling amid new geopolitical rivalries. Work forces are aging, potentially adding upward pressure on wages.
The best guess for Canada’s long-term interest rate level is provided by the central bank’s neutral rate. This is the estimate of where the bank’s overnight policy rate would settle if inflation was on target and the economy was growing at its full potential. Essentially, it’s the rate that neither speeds up nor slows down the economy.
The Bank of Canada thinks the neutral rate is somewhere between 2 and 3 per cent.
Getting to the neutral rate implies inflation is under control. That’s not the current reality. In the near term, the question is whether the central bank will raise rates again.
It has kept monetary policy in a holding pattern since January, although Mr. Macklem and his team have maintained a hawkish tilt. They’ve said repeatedly that they’re willing to raise interest rates again if they’re surprised by stronger than expected inflation, economic growth and employment data.
The past few weeks have delivered a string of upside surprises. Canadian employers added 41,000 jobs in April and the unemployment rate remained at 5 per cent, near a record low. Meanwhile, the housing market has begun to rebound, with an uptick in home prices and sales volume in April.
This week, Statistics Canada reported that the annual rate of Consumer Price Index inflation ticked back up to 4.4 per cent in April, from 4.3 per cent the previous month.
Mr. Macklem refused to say how this data would influence his decision at the next interest rate decision on June 7. Although he did acknowledge that “the April CPI report did come in stronger than we expected.”
The Bank of Canada expects inflation to fall to around 3 per cent by the summer, and to return to the 2-per-cent target by the end of 2024.
Until recently, financial markets expected the Bank of Canada to hold its benchmark rate at 4.5 per cent until the fall, and then to start lowering it near the end of the year.
After this week’s hot inflation data, interest rate swap markets are pricing in a 20 per cent chance of a rate increase in June and a roughly 50 per cent chance of a rate hike in July, according to Refinitiv data. Markets no longer expect rate cuts this year.