Bank of Canada Governor Tiff Macklem holds a press conference in Ottawa on July 12.Sean Kilpatrick/The Canadian Press
Bank of Canada Governor Tiff Macklem said that the surge in bond yields in recent months is tightening financial conditions, but that does not preclude the possibility of more interest-rate hikes from the central bank.
Speaking to reporters in Marrakesh, where he is attending the fall meetings of the International Monetary Fund, Mr. Macklem said that the central bank is monitoring the jump in long-term bond yields ahead of its next interest-rate decision on Oct. 25. Interest rates on 10-year Government of Canada bonds, for instance, have risen by more than half a percentage point over the past three months, to the highest level since 2007.
“To the extent that financial conditions are tighter, that is something that we would take into account in our own monetary policy decisions,” Mr. Macklem said.
But he added that “to the extent that higher long-term rates reflect expectations of future monetary policy, they’re not a substitute for doing what needs to be done to get inflation to come back to our target.”
The Bank of Canada held its policy rate steady at 5 per cent in September, but said that it could raise interest rates again if inflation remains stubbornly high and economic growth does not slow as much as expected.
The rise in global bond yields since the middle of the summer has significantly increased borrowing costs for households, governments and businesses. Canadian homeowners, in particular, are now looking at much larger payment shocks when they renew their mortgages in the coming years.
Mr. Macklem said this hasn’t really changed the central bank’s outlook for slow, but mostly positive economic growth in the coming quarters. “We’re not going to be forecasting a serious recession,” he said, referring the bank’s new economic projection that will be released on Oct. 25.
Some officials at the U.S. Federal Reserve have suggested in recent weeks that higher long-bond yields may act as substitute for further monetary policy tightening. “If long-term interest rates remain elevated because of higher term premiums, there may be less need to raise the fed funds rate,” Dallas Fed president Lorie Logan said in a speech earlier this week. Term premiums are the amounts investors demand to hold long-term assets in the face of uncertainty.
While borrowing costs have risen significantly, inflation has been moving in the wrong direction in recent months in Canada. Consumer Price Index inflation rose to 4 per cent in August, up from 2.8 per cent in June and 3.3 per cent in July. Worryingly for the Bank of Canada, core inflation measures, which strip out the most volatile price movements, also climbed.
“We’re not really seeing downward momentum in underlying inflation and that is a concern,” Mr. Macklem said. He noted that on a three-month moving basis, core inflation measures have been stuck in the 3.5-per-cent to 4-per-cent range for the past six or eight months. Statistics Canada will publish September inflation numbers on Tuesday.
Because interest-rate changes work with a lag, the Bank of Canada doesn’t set monetary policy based on today’s inflation. It tries to forecast where price pressures will be in the future, based on various economic telltales. Right now, Mr. Macklem and his team are focused on four: the speed of economic growth compared with the economy’s potential, inflation expectations, labour costs and corporate price-setting behaviour.
On the first metric, which central bankers call “excess demand,” things are generally moving in the right direction. Canada’s gross domestic product contracted slightly in the second quarter, and economic activity flatlined through July.
But the other metrics aren’t co-operating as much. Short-term inflation expectations remain high, companies continue raise prices more frequently than normal and wage growth is running at between 4 and 5 per cent. “Unless we get a big pickup in productivity growth, that’s not consistent with our 2-per-cent inflation target,” Mr. Macklem said.
Over the next week and a half, the central bank’s governing council will be debating whether or not it has raised interest rates enough. Financial markets are pricing in a 35-per-cent chance the central bank raises interest rates by a quarter percentage point.
“Do we stay with the policy rate of 5 per cent and let past interest-rate increases work through the economy and relieve price pressures? Or is the weight of the evidence of all those economic indicators, when you put them together, is it telling us that more action is needed to restore price stability?” Mr. Macklem said.
“We don’t want to do more than we have to, we don’t want to make this more painful than it has to be. But we don’t want inflation to persist and become entrenched in the economy.”