In the current roar of high inflation, last week’s quarter-point increase in interest rates by the Bank of Canada will likely be a whisper too quiet for most Canadians to hear.
According to a flurry of statements and speeches, including testimony to a parliamentary committee, the central bank’s governor, Tiff Macklem, has begun his long-awaited attack on inflation that’s meant to convince Canadians they should not expect price rises to continue.
Rate hikes, the Bank of Canada governor said, were “needed to keep inflation expectations well anchored and to limit the broadening of inflationary pressures so that inflation falls back as supply disruptions ease.”
Markets send a different message
But while the central bank battles to quell inflation expectations, the world economy is conspiring to send a very different message.
Russia’s attack on Ukraine has driven energy prices sharply higher, and Canadians who have not yet invested in an electric vehicle have never seen pump prices at this level. Global food prices are expected to surge as grain and fertilizer suffer shortages.
The loss of production from an entire country, Ukraine, and economic sanctions levelled by the West against Russia have added new distortions to supply chains, already the main villain in Macklem’s inflation story.
That contradictory message — that you should expect inflation to continue to rise, not fall — isn’t just coming from outside the country. Last week, Canadian banks reported a new surge in lending, pouring more money into the country’s overheated economy. If fear of a future stream of increasing central bank interest rates was supposed to deter borrowers, it hasn’t convinced them yet.
Not only do world markets seem to be colluding against Macklem, but the central bank itself is implicated in rising prices. Economists say the increase in rates themselves will actually lead to an increase in inflation, as the rising cost of payments on huge mortgages begins to show up in the consumer price index (CPI).
As Al Ullman, the late U.S. politician who chaired the House ways and means committee, once said in 1980, when inflation was hovering at around 13 per cent: “To depend on monetary policy to slow the economy by increasing interest rates adds to inflation because that increase goes into the cost of everything we buy.”
It’s happening again
Well-known Canadian economist Eddy Ng, the Smith Professor of Equity and Inclusion in Business at Queen’s University in Kingston, Ont., said the same thing is happening again today. In fact, he said, that’s the intent of rate increases.
“The conventional wisdom is to raise interest rates because that will make it more expensive for consumers and businesses to borrow, and hopefully that would stop the consumption,” Ng said in a phone interview last week after the bank’s rate hike.
“I think that’s a fundamental misreading of the economy,” he said.
Ng said the problem now is a shortage of supply — and raising borrowing costs will merely make it harder for businesses to contribute to filling those supply gaps.
The other peculiar thing about the effect of rising interest rates on mortgages, he said, is that while rising house prices are considered an increase in asset value and therefore not counted in inflation, the higher level of interest paid on those large mortgages feed straight into the CPI as part of Statistics Canada’s shelter component.
From his series of speeches and appearances last week, it’s clear that Macklem realizes he faces clashing forces that are hard to reconcile.
Asked by Quebec MP Gabriel Ste-Marie, a member of the finance committee, if he’s worried about stagflation — a recession combined with rising prices — as some economists have predicted, Macklem said he was not, predicting that the Canadian economy — seen growing at a surprisingly strong 6.7 per cent in the latest quarter — will continue to surge this year and next.
Although he did not appear at either event, Canadian economist David Rosenberg’s worry that rising rates would “kill the Canadian economy” popped up twice: in questions at Macklem’s parliamentary committee appearance and at a news conference with business reporters.
“We think the economy can handle higher interest rates,” Macklem responded. “We think the economy needs higher interest rates.”
The harder question is the one about consumer inflation expectations. As repeatedly stated by Macklem and Jerome Powell, his counterpart at the U.S. Federal Reserve, central banks want to stop consumers and businesses from expecting that prices will rise.
“What monetary policy can do is make borrowing more expensive, which slows domestic demand,” Macklem said in one of his speeches last week. “For households and businesses that are already feeling the pinch of inflation, the higher cost of borrowing can be doubly painful. But tighter monetary policy is necessary to lower the parts of inflation that are driven by domestic demand.”
But as the bank governor squarely admitted, he may be facing overwhelming odds in trying to change the view of consumers. He expects the world price of oil alone, which continued to trade above $110 US a barrel, could push the price of Statistics Canada’s basket of consumer goods sharply higher.
“If a price of $110 were to be maintained, you could expect that that would add about another, further, percentage point to inflation,” said Macklem, who observed that not only oil but other commodities and manufactured goods had risen in price due to Russia’s invasion of Ukraine.
“Since the invasion, we’ve seen a lot more volatility in these prices. I’m not going to give you a new forecast, but what’s pretty clear is that they are going to add further to inflation in the near term, and we can expect inflation to be higher in the near term as a result.”
So much for reducing our expectations.
Friday’s jobs numbers will offer another reading on the strength of the Canadian economy. But with a soaring need for the export of Canadian commodities, a rising demand for workers, a surge of new borrowing and investment, GDP growth at multi-year highs, a housing market that just won’t quit and what Macklem called “solid momentum” in domestic demand, it is clear that a whisper of rising interest rates will not be enough to slow down the party.
Macklem will have to shout.