FLCA - The Bank Of Canada Hits Pause. Now What?
2023-03-11 01:17:00 ET
Summary
- The Bank of Canada pauses rate hikes, but stands ready to hike again.
- Why the policy gap between the Fed and the BOC could be trouble for the loonie.
- Why the jobs market is making the jobs of policy makers so difficult.
The Bank of Canada kept its key overnight rate on hold at 4.5%. But it did so as the Federal Reserve signaled U.S. rates could go higher than expected. Andrew Kelvin, Chief Canada Strategist at TD Securities, discusses what to expect going forward.
Transcript
Greg Bonnell: The Bank of Canada is reaffirming its conditional pause on rate hikes, keeping them on hold at 4.5%. With the US Federal Reserve warning higher rates may be needed to slay inflation, how much longer can our central bank hold borrowing costs at the current level?
Joining us now with more, Andrew Kelvin, Chief Canada Strategist at TD Securities. Great to have you back on the program, Andrew.
Andrew Kelvin: Thank you for having me.
Greg Bonnell: All right, so we got the Bank of Canada saying, we are going to stay on hold. We're going to try to figure out where we are right now. But then we have the Fed making these downright hawkish statements about how far they need to go. This is a bit of a disparity between the two central banks. How do we see that as investors? Where do we think they're going to be headed?
Andrew Kelvin: There's absolutely is a disparity. We always thought the Federal Reserve would move higher this cycle than the Bank of Canada. We also thought the Federal Reserve would finish at a higher terminal rate, just given the household leverage dynamics in Canada are somewhat more acute than they are in the United States. So each rate hike in Canada should bite a little bit harder than a rate hike in the US would.
So it's not inconsistent in that sense. It does speak to this sort of underlying tension, though, where the Bank of Canada declared their conditional pause in January. I think to a lot of people it seemed maybe a little bit premature, maybe a little bit overly confident in their assessment of the economy. Because while I do share this view that growth is likely to slow this year, we haven't seen really material signs of it yet.
And if you look at the most recent jobs figures for the month of January, that really laid that out. We're running into a very tight labor market, which the Bank of Canada touched on today, and the economy certainly isn't showing the signs of slowing, the Bank of Canada, perhaps, had suggested when they put that conditional pause in in January.
Now, the fourth quarter was a little weaker than expected. CPI inflation is involving in line with the Bank of Canada's last forecast, which is why we expected that they would stay on hold today. But as we go into April, into June, we will need to see a pretty notable deceleration in economic activity in Canada to justify the Bank of Canada's hold.
So that's the first piece of this. It may be that the Federal Reserve is seeing some strength on the ground that the Bank of Canada is not. But I would suggest that in an environment where the United States is showing significant resilience is probably going to be an environment where the Canadian economy shows significant resilience.
The second piece that will come into play is the currency. Because if the Federal Reserve really steps on the gas or brakes, depending on how you want to think of this analogy, but the Federal Reserve decides to tighten more than the market expects, that will put pressure on the Canadian dollar. And while the Bank of Canada can be tolerant of fluctuations in the Canadian dollar, too much depreciation in the currency is inflationary and could bring them back into play and could force their hand.
So it is something to continue watching in the United States. A degree of extra hawkishness compared to the Bank of Canada is to be expected. But there are bounds to how much those two central banks can diverge.
Greg Bonnell: That sounds like it leaves the Bank of Canada in a very hard place. You just talked about the debt dynamics we have in this country. Good reason for them to be concerned about higher borrowing costs really biting into households and their ability to make their debt payments. But at the same time, the dynamics south of the border, I wouldn't want to be-- I don't even know if I'd want to be a central bank governor on a good day, and these seem to be very hard times to be a central bank governor.
Andrew Kelvin: It is a thankless job, no doubt. So in terms of one thing to think that is in common between Canada and the US, in both countries there were significant piles of excess savings that were accumulated. That is something that can help buffer the impact on household spending in Canada, even though we have these sort of more pernicious debt dynamics. And I will say, the Bank of Canada did say in their statement today that restrictive monetary policy continues to weigh on household spending. But I would put forward, given the tightness in the labor market, we need to see further deceleration going forward.
Greg Bonnell: So the Bank of Canada needs to see these things as turn in the economy, that's some indications, with the GDP underperforming but the labor market still being hot, so it's a little mixed on that picture. At some point, we're going to get a spring budget from the federal government. Then that's the fiscal side. Is there a danger now that those two camps start working at odds with other? The monetary policy is trying to achieve one thing, but fiscal policy sometimes wants to help voters in need.
Andrew Kelvin: It's always a danger, in both directions, really. There have been occasions in other countries where central banks have tried to loosen policy while a fiscal agent is cutting spending, which also works against the central bank's goals. Obviously, in an inflationary environment, the risk would be more government stimulus would make the Bank of Canada's job harder and ultimately cause them to lift rates more.
I haven't seen any indication that we're looking at a really aggressive budget. Now, political calculations change all the time. Certainly something could shift in the polls or a government decides that they have a shiny new policy they think will go over great with voters. And things can change. I would just observe, based on the fiscal update we got in November, it didn't seem like a government that was planning a very significant fiscal expansion.
And there's no need to see an election this year. It's a minority government. It's always a risk. But given that the next scheduled election isn't for a few years now, I don't know that this is the time where you maybe sprinkle that extra stimulus across the country to try and win a few extra votes.
So it is a risk. It's something we will be watching for very closely is going to April. It's not part of our base case, however.
Greg Bonnell: Part of the Bank of Canada's base case today, as I went through their statement, was they think that inflation is going to get down around 3% by the middle of this year. We're not that far off from the middle of this year. Can they achieve that?
Andrew Kelvin: I think so. There's a lot of base effects here. Inflation was running extremely hot, I suppose. Price acceleration was quite high through the first part of 2022. So as those months of inflation fall out of your year-over-year calculation, inflation just mathematically falls. So you can get down into the mid 3s without too much difficulty by the middle part of the year.
I think the tricky part is moving from 3.5% to 2.5%, because underlying inflation is running at a rate that is consistent with more sort of 3.5% inflation. I'm looking at the core measures here, sort of annualize them over a three-month basis. So you need to see more disinflation on the month-by-month prints to actually have a path to 2% inflation in 2024, which is ultimately the Bank's goal.
That 3% midyear inflation rate that they talked about, that's a milestone. It's a signpost. It's not ultimately where they're trying to get to. And if we wind up at the end of 2023 and inflation is still 3.5%, that'll be a sign that the Bank of Canada made a dovish policy mistake.
Greg Bonnell: The range is 1% to 3%, right? And then some debate starts to happen, as the fact that would they be happy with something at the higher end of the range. The sweet spot is 2%. But if you do have a range up to 3%, would they feel like mission accomplished, to a certain degree?
Andrew Kelvin: I think they'd be a lot more comfortable being within the range than being outside the range. Ultimately, they're trying to get to 2%. They've been trying to get to the midpoint of that range. And I think particularly given the experience of 2022, certainly, and also what we're experiencing today, inflation expectations in the short term, at least, are elevated. There is an element of preserving credibility they need to take into account.
So in an environment where we were just sort of going along between 1.5% and 2.5%, and maybe inflation hung out at 2.7% for a little while, they may not be overly concerned, as long as they thought inflation was stable going forward. In an environment where they have really missed their target for a long period of time now, I think it's very difficult to get to 2.9% and say, mission accomplished. They really need to achieve that 2% number to restore the credibility in that 2% inflation target.
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The Bank Of Canada Hits Pause. Now What?