Canada’s central bank has taken the rare step of providing guidance on the path of interest rates, as it aims to keep expectations secured while it unwinds stimulus in the economy faced with a runaway inflationary situation.
However, economists have predicted that the application of the same strategy as that used during the COVID-19 pandemic — a version of the “forward guidance” may not be effective. As such, the central bank should consider a more effective approach to get rates into the neutral range and then hold.
The Governor of the Bank of Canada,Tiff Macklem has now considered that the policy rate, now at 1%, could climb above 3%, following repeated requests from the Bank of Canada’s officials that “We need higher interest rates”
Although, Royce Mendes, head of macro strategy at Desjardins Group, has said that “This is a more aggressive form of communicating that monetary policy accommodation needs to be removed. However, the question to be asked is: Is it aggressive enough when inflation is at 6.7%?
He added that, “Just talking about it might not be enough, because the longer we leave monetary policy to stimulate the economy, the more likely it is that inflation expectations … become unmoored.”
Canada’s inflation rate hit a 31-year high in March, testing the credibility of central bankers tasked with keeping price growth at the 2% midpoint of a 1%-3% range. The big risk is that the price rises will cause Canadians to lose faith in the target, with inflation drifting persistently higher.
The Bank of Canada has come out to defend itself as it noted that what it is doing is not “forward guidance,” a monetary policy tool only used twice before and only in times of crisis. Rather, it acknowledged the current policy is a departure from the usual practice of avoiding forward-looking statements on interest rates.
“Right now (the Bank of Canada’s) Governing Council states that it is important that Canadians understand that interest rates are on an upward path so that they can plan accordingly,” said Paul Badertscher, director of media relations at the central bank.
What the Bank of Canada has done in recent times – ‘SOONER RATHER THAN LATER’
The Canadian central bank has raised its policy rate twice during the current tightening cycle. But at 1%, the rate is less than half the neutral rate – the level at which economic activity is neither stimulated nor constrained – and therefore still very stimulative to an already lathered economy.
So, the Bank of Canada is being explicit in saying that higher rates are coming as a stop-gap measure to try to cool demand until it can move into the neutral range, which will take at least four more months at the current pace, economists said.
At the Senate Committee meeting late last month, the Governor of the Bank of Canada, Macklem mentioned that “If we don’t keep inflation expectations well anchored, inflation will get stuck. It won’t just come down.”
On the market aspect, another 50-basis-point increase is fully priced in for the June 1 interest rate decision, with money markets betting the policy rate will be around 3% by the end of this year.
Yet, some economists say actions are stronger than words, and the central bank should hike its policy rate by 75 or even 100 basis points in its upcoming decisions, and then use guidance to signal a pause.
Thus, Derek Holt, head of capital market economics at Scotiabank mentioned that, “it would be rather better if they get there sooner rather than later and on an even more expedited path since, “The economy’s characteristics now say that you should already be at neutral, if not higher.”
