The Bank of Canada has laid out its 3-to-2-per-cent solution. And like a lot of hard medicine, Canadians aren’t going to like the taste of it.
That’s the message the central bank delivered in Wednesday’s interest-rate decision and accompanying quarterly Monetary Policy Report. It is confident that the country’s inflation rate, which topped 8 per cent last summer, will be down to 3 per cent by this summer. But that’s not good enough.
“The destination is not 3,” Governor Tiff Macklem said in a news conference after the announcement.
No, Mr. Macklem’s unequivocal goal is to get inflation back centred on the bank’s long-standing 2-per-cent target. That is the only way that he is willing to define victory in this inflation battle.
The good news – as Mr. Macklem’s rehearsed talking points emphasized – is that inflation is coming down, fast. “That is going to be some relief for Canadians,” Mr. Macklem said. (Twice.)
But if you thought that relief from the bank’s 15-year-high interest rates was coming wrapped in the same package, you’re going to be disappointed. Mr. Macklem told financial market participants flat out that their assumption of a rate cut by the end of the year (implied by market prices for interest-rate swaps) is not in the bank’s playbook.
“Based on the information we have … that doesn’t look today like the most likely scenario to us,” the Governor said.
“We’re going to need to see more progress if we’re going to get inflation down to the 2-per-cent target. And, so, what that means is that it may be necessary for interest rates to stay elevated for longer to get that job done.”
So, yeah, the Governor may have led with the good news, but his main message was the bad news. Interest rates aren’t coming down. In fact, Mr. Macklem divulged, he and his colleagues on the bank’s governing council discussed whether rates needed to go higher to hammer inflation down to the target. So get those rate-cut daydreams out of your head.
Still, beyond the Governor’s rhetoric, much of what the bank is saying about inflation and the economy indicates that the next rate move will be down, not up. Most importantly, the bank predicted in its Monetary Policy Report that the economy will move into “excess supply” in the second half of this year. This means that output will exceed demand – a distinctly disinflationary state.
The whole point of the current unusually tight rate policy was to quell the opposite condition, where demand exceeded supply. If that job is going to be done within the next six months, there’s zero justification for even tighter interest rates. Frankly, it would be entirely reasonable to argue that once the economy is in excess supply, the bank could begin to ease rates to, at least, a less restrictive level.
But it looks like Mr. Macklem wants to keep dousing rate-cut expectations with cold water until the Bank of Canada is much closer to changing its policy stance. After all, it doesn’t serve the bank’s objectives to have markets pricing in rate cuts. That kind of talk leads to lower interest rates in the financial markets, which dampen borrowing costs, which works counter to the bank’s goal of cooling economic activity through high rates.
Best, then, to remind markets and consumers at every turn that the bank isn’t prepared to lower rates – until it is.
At least the bank is helping the markets spot the moment when its tune might change, by specifying the indicators the governing council will be watching to determine when 2 per cent comes into view. It embedded that information in its rate decision statement – an enshrinement that makes this the new gospel for predicting the bank’s next move.
First, the bank said, consumers’ heightened inflation expectations are proving sticky. Second, both price and wage growth in the service sector are “elevated”; and finally, it said, “corporate pricing behaviour has yet to normalize.”
You know how the Bank of Canada spent much of the past year, while it was raising rates in leaps and bounds, telling us how important it was to snuff out expectations of high inflation before they became entrenched in the public psyche? Well, guess what? All of the elements of that final one percentage point in the inflation fight – the gap between 3 per cent and 2 per cent – have a strong whiff of heightened expectations to them.
Mr. Macklem and his colleagues seem to believe that to break those expectations, they need to not only hold the line on interest rates for longer, but also hammer away at the message that it’s not letting up. So, yes, there’s a certain amount of demoralizing involved in both the delivery and the communications of policy.
Regardless of the strategy, it’s clear that after two years of elevated inflation, the upward drift in expectations has become the last, and toughest, nut to crack in solving this problem. At some point in the next several months, Mr. Macklem will have to decide whether his 3-to-2-per-cent solution is working. Or whether crushing that last percentage point is worth the pain.