Bank of Canada Governor Tiff Macklem and Senior Deputy Governor Carolyn Rogers hold a news conference at the Bank of Canada in Ottawa on July 12.Sean Kilpatrick/The Canadian Press
The Bank of Canada views its inflation-fighting monetary-policy glass as half-empty. It seems determined to fill it with interest-rate increases.
The central bank’s statement accompanying Wednesday’s quarter-percentage-point hike in its policy rate was a distinctly pessimistic document. Despite encouraging evidence in much of the economic data since the previous rate hike, in June – easing inflation, slowing economic growth, slowing wage growth, softening business and consumer expectations – the bank seems determined to point out the clouds surrounding every bit of blue sky.
Its new economic forecasts predict a substantially slower-than-anticipated closing of the gap between overheated demand and the economy’s capacity to supply it (known as the output gap), as well as a much slower return to the bank’s 2-per-cent inflation target. Those numbers cemented its case for the rate increase. And this doesn’t sound much like a bank that’s finished.
At very least, it’s keeping its options wide open to push rates higher, in order to quash inflation and “excess demand” that it describes as “more persistent” than it had expected. (It’s no accident that the word “persistent” appears in the rate announcement four times.)
“If new information suggests we need to do more, we are prepared to increase our policy rate further,” Bank of Canada Governor Tiff Macklem told reporters after the rate decision. “But we don’t want to do more than we have to.”
Mr. Macklem’s sense of where that line is differs from that of a growing number of economists. While most experts were convinced that the bank would raise its policy rate Wednesday, many felt that the rate was already proving high enough to continue to slow demand and inflation pressures.
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By the bank’s own admission, last year’s steep rate hikes are still working their way through the economy; we haven’t yet seen their full slowing effects on demand and growth. The policy rate is fairly deep into what economists call “restrictive” territory, applying a forceful economic brake even if it doesn’t go any higher from here.
Still, the bank has made it clear that it’s not willing to wait to see whether it got the economic call right or wrong. And while Mr. Macklem says the bank is trying to strike a balance between over and undertightening its policy, it seems that when push comes to shove it’s still more inclined to overshoot.
For more than a decade, the Bank of Canada has both preached and occasionally practised flexibility around its inflation target, particularly when it comes to the amount of time it is willing to wait for inflation to return to the desired 2 per cent. Given the current complicated economic and inflation climate, one might argue that this is an apt time for the central bank to have some patience for a longer journey back to the target, so long as its rate policy is broadly working – as Mr. Macklem has said, many times, that it is.
But the bank has a fear – a preoccupation, even, though not an irrational one – that inflation will simply get stuck at some level above 2 per cent, and that we will come to accept that as a new norm. Mr. Macklem is determined not to let that happen. Which leaves very little tolerance for taking the scenic route.
The implication is that as long as the bank isn’t convinced the economic outlook has improved – and it will take considerable convincing, given its pessimistic inclination – then it probably isn’t done raising rates. And it will probably be inclined to keep rates high until it is absolutely sure that the 2-per-cent target has been achieved.
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Of course, this new trajectory for inflation – and, by extension, rate policy – is only as good as the economic forecasts on which it is based. If you find the bank’s new forecasts discouraging, you might take solace in the evidence that the bank’s predictive abilities over the 12-to-24-month time frames that matter most for monetary policy haven’t been great for quite a while now.
Two years ago, the bank projected that inflation, then at a little more than 3 per cent, would retreat to the 2-per-cent target in 2022; it predicted that the economy, then in excess supply, would come into balance in the second half of 2022. Instead, inflation was 8 per cent by mid-2022, and the economy had already swung into excess demand during the first quarter.
Just three months ago, the bank thought inflation would return to 2 per cent by the end of 2024, and the output gap would close around the middle of this year. Now, the inflation target has been booted six months down the road, to mid-2025, and the closing of the output gap has shifted roughly nine months farther away, to early 2024.
This is not meant as a criticism; economic forecasting is hard, and it gets harder the longer the time frame you are looking at. But it’s pretty clear that the Bank of Canada’s economic outlook is not nearly as rock-solid a foundation for the path and pace of interest-rate policy as one might like.
Wednesday’s revised projections suggest that more rate pain is coming, but there’s no basis in recent history to suggest that they will serve as an accurate prediction of where we will be even a few months from now, let alone two years from now. Mr. Macklem and his colleagues may be prudently pessimistic, but that doesn’t mean they’ll be proven right.