With every new inflation report, the job facing the Bank of Canada gets that much harder.
The alarmingly rising tide of inflation – reaching 7.7 per cent in May, the highest in an astonishing 39 years – presses the central bank to respond with bigger and faster interest-rate increases. The sweet spot for getting that grim task just right shrinks. The risk of getting it wrong – a recession – grows.
A soft landing for the economy? Sure, that’s still the dream. But as the task of stomping down inflation continues to grow, it may take more luck than skill to get there. Frankly, being delicate isn’t the top priority at this stage.
“The most important thing is to get inflation back to target,” Bank of Canada senior deputy governor Carolyn Rogers said at a Globe and Mail event a couple of hours after the release of the inflation report. “Of course, we want to do that with the least amount of unintended consequences as possible. ... That’s what we’re aiming to do, that’s why we’re increasing rates. That’s why we’re doing it quickly.”
That May inflation report, published Wednesday by Statistics Canada, probably cemented a 75-basis-point (three-quarters of a percentage point) rate hike by the Bank of Canada at its next rate decision in mid-July – which would be the bank’s biggest single rate increase since 1998.
Frankly, you could make a compelling argument for even more, given the situation and the timing.
The central bank has said repeatedly it wants to quickly get its key rate at least up to levels it considers “neutral” – i.e. where its rate neither stimulates nor inhibits economic activity. It estimates the neutral rate to be somewhere between 2 and 3 per cent. A 75-basis-point hike in July would put the rate at 2.25 per cent – still toward the low end of the neutral range.
While the odds of a July increase of one full percentage point don’t look high at this stage, there are some good reasons for the Bank of Canada to look seriously at that option. Such a hike would put the bank smack dab in the middle of its neutral range, which achieves at least the first stage of the bank’s rate intentions. It can say that it has withdrawn its stimulative rates, before it shifts into summer mode following the July rate decision – a long stretch of relative public silence that lasts until the next rate decision after Labour Day.
The U.S. Federal Reserve is also scheduled to set its key rate two weeks after the Bank of Canada’s July announcement, and looks poised to make its own jump to 2.5 per cent. The Bank of Canada might want to pre-emptively keep pace with its U.S. neighbour before checking out for the summer.
Regardless of the amount, it’s increasingly clear that merely returning to neutral rates won’t be anywhere near enough. The bank will need more restrictive interest rates if it is going to apply some serious brakes to domestic demand, which is running much too far ahead of the capacity to supply it. Bottom line, the bank needs to slow the economy.
It should be possible, at least arithmetically, to do that without triggering the kind of employment slump that is a hallmark of any true recession. As Statistics Canada reported this week, Canada had nearly one million job vacancies in the first quarter, at a time of 50-year low unemployment – evidence of an enormous gap between labour supply and demand. Bank of Canada officials have said that this leaves a lot of room to dampen demand – like, a million jobs worth of room – before you start hurting employment appreciably.
“We see a path to do that. Our view is we can take some of the excess demand out of the economy, bring it back into balance,” Ms. Rogers said.
But just because the numbers work doesn’t mean that engineering such a feat is easy. Far from it. And any central banker will tell you – it’s so commonly understood that it’s almost reflex – that interest rates are a blunt instrument. They are not at all well suited to the delicate economic surgery that we’re trying to perform here. No one can really say how high, or how fast, rates must climb to hit that sweet spot where we slam the brakes on demand without slamming our collective heads into the windshield.
If you’ve been watching this game for a few economic cycles (old-guy disclosure: I have), you know from experience that by the time you’re hearing and reading the phrase “soft landing” all over the place, that possibility has almost certainly already come and gone. Far more often than not, it’s the wishful thinking of those who can see the ground fast approaching underneath them.
What’s more, the time for the Bank of Canada to worry about being gentle has passed. It just needs to get inflation on the ground – any way it can – before an awful year begins to fester into a generational problem. Yes, things have become that serious.
Brace for impact.
The Globe and Mail
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