Members of the Bank of Canada’s governing council are wary of cutting interest rates too early and having to reverse course if inflation rebounds, according to a summary of the discussions that took place ahead of the central bank’s Jan. 24 rate decision.
Two weeks ago, Bank of Canada Governor Tiff Macklem and his five deputies held the bank’s policy interest rate steady at 5 per cent for the fourth consecutive time. They said they were unlikely to raise interest rates further, but maintained that it was too early to start talking about cuts.
The summary of deliberations, published Wednesday, shows the group in a cautious holding pattern: fairly confident that monetary policy is working to get inflation under control, but nervous about throwing in the towel too early.
“While members did not want to make economic conditions more painful than necessary, they were particularly concerned about the persistence of inflation and did not want to lower interest rates prematurely, only to have to raise them again to get inflation back to the 2 per cent target,” the summary said.
The annual pace of inflation had fallen to 3.4 per cent in December from a mid-2022 peak of 8.1 per cent, and economic growth in Canada has effectively stalled since last summer. High interest rates are designed to slow economic activity, in order to reduce price pressures.
The decline in inflation and stagnant economy have spurred speculation that the Bank of Canada will start easing monetary policy in the coming quarters. Financial markets are pricing in a roughly 70-per-cent chance that the first rate cut will happen in June.
The summary of deliberations offered no guidance about the timing of potential rate cuts, saying that “based on the information that was available, it was difficult to foresee when it would be appropriate to begin cutting interest rates.”
It did, however, give some insight into how Canada’s top central bankers are thinking about different drivers of inflation, and how different risks might affect the path of monetary policy.
“Members discussed the risk that monetary policy could have a greater impact on consumer spending than expected, particularly as consumer confidence was already low,” the summary said. “In this scenario, monetary policy would likely need to ease earlier and more quickly than anticipated.”
On the flipside, the group “also saw a risk that inflation could be more persistent than expected,” if inflation expectations remain elevated, wages continue to rise quickly and shelter costs don’t moderate. “In this scenario, monetary policy would need to remain restrictive for longer.”
Fundamentally, the bank wants to see a further decline in its preferred measures of core inflation, which strip out the most volatile price movements. These metrics have been stuck in the 3.5-per-cent to 4-per-cent range for most of the past year. The bank has said it doesn’t need inflation to drop all the way back to its 2-per-cent target before cutting rates, but that it does need to see “clear downward momentum in underlying inflation.”
It’s also looking at other signposts that could indicate inflationary pressure, including corporate price-setting behaviour, the overall balance of supply and demand in the economy, and people’s beliefs about future inflation. The meeting summary said the governing council was seeing progress on the first two points, but less on the third: inflation expectations remain elevated, possibly because people are still seeing food prices and housing costs rise quickly.
Inflation’s last mile to Bank of Canada’s 2-per-cent target could be a long and winding road
There are two key areas that remain a headache for central bankers: wage growth and shelter inflation.
On an annual basis, wages have been rising in the 4-per-cent to 5-per-cent range for more than a year. That’s a level the bank does not think is compatible with its 2-per-cent inflation target unless workers become more productive.
Meanwhile, rising shelter costs remain the biggest driver of overall consumer price index inflation. That’s because of a jump in mortgage interest costs, tied to past rate hikes. It also has to do with rapidly rising rents, which are more the result of high population growth running into a lack of rental housing supply.
On Tuesday, Mr. Macklem gave a speech arguing that monetary policy alone won’t address Canada’s housing affordability problems, and that all levels of government need to work together to boost housing supply.
The summary noted the risk that a real estate rebound this spring “could keep CPI inflation materially above the target even while price pressures in other parts of the economy abated.”
Mark Rendell