FLCA - Why The Bank Of Canada Says The Inflation Fight May Not Be Over Yet
2023-12-08 06:35:00 ET
Summary
- Why the Bank of Canada is keeping rate hikes on the table.
- Is it too soon to be considering potential rate cuts?
- What to expect from the Bank of Canada in 2024.
The Bank of Canada did as expected by keeping rates on hold. Andrew Kelvin, Head of Canadian and Global Rates Strategy with TD Securities, explains why the central bank is likely keeping the possibility of another rate hike on the table, even as inflation shows signs of cooling.
Transcript
Greg Bonnell: The Bank of Canada says higher borrowing costs are restraining spending, helping reduce inflation. But the BOC is not willing to declare mission accomplished just yet. It's holding its key rate at 5%. For more on the state of the economy and where rates could be headed from here, we're joined by Andrew Kelvin, Head of Canadian and Global Rate Strategy with TD Securities. Andrew, great to have you back on the program.
Andrew Kelvin: Thanks for having me.
Greg Bonnell: All right. So we got the statement today. We got the decision. I think we could say, as expected. But as we go through the details there, did anything stand out to you as interesting? I mean, they're still maintaining that posture of like, hey, we'll raise if we have to raise again.
Andrew Kelvin: Sure. I think if there's one takeaway for me from this statement, which, it was very short, first off. They didn't have a whole lot to say. And it was, I think, largely as expected tonally. They do seem quite a bit more comfortable with the idea that perhaps they have done enough to bring inflation back to target. The language suggested that they think they are another step or two down the path towards 2% inflation.
If you go back to last October, they talked about inflation risks worsening. The minutes from the October meeting suggested that some members of the governing council weren't convinced that rates were actually high enough to achieve their inflation target. That sort of lack of comfort, I would say, with the inflation backdrop I think was really evident in that October statement.
December was, I think, much more muted. They talked about the Canadian economy seeing growth stall over the last few quarters. They talked about slower growth globally. They several times talked about how high rates were effective in quelling household spending. It just seems like they're much more comfortable that they are in fact done hiking rates.
Now you mentioned that they did say, well, we will hike rates again if we need to. Inflation is not low enough. And it's true that inflation is not low enough. Their target's 2%. Inflation's around 3%. So, I'd be concerned if they were saying that--
Greg Bonnell: That's right. Mission accomplished, victory lap. Don't worry about it. Enjoy the holidays.
Andrew Kelvin: Exactly. It might make it very nice holidays, but it would probably be irresponsible central banking. * The thing with talking about being willing to hike rates again is as long as you have that threat out there, however theoretically, it constrains market pricing of cuts. If they had taken away the line about being willing to hike again if needed, markets would have taken that as an indication that rate cuts were imminent. And you would have seen bond yields move lower across the front end of the yield curve, loosening financial conditions.
In order to get the most impact out of the hikes that are already in the system, and therefore, in order for them to be able to avoid hiking more, they need to maintain this sort of threat, credible as it may be, that they will hike rates again if needed to prevent markets from becoming too complacent, to prevent households from getting too complacent. Because ultimately what they want is these rates to produce more savings, less spending. And by threatening to raise rates if we don't get back to 2% inflation, it just allows them to have the maximum impact from those hikes.
Greg Bonnell: Now as you said, we got a statement today, not a very long one. We didn't get the press conference. There was no monetary policy report. So, there wasn't a chance to ask questions of Governor Tiff Macklem. If there had been, I imagine someone in that room-- and I used to be in that room in my former job-- would say, so when are the cuts coming? And he's been pretty consistent with saying, much too early to start talking about that. But of course, TD Securities has a view on when the cuts are coming.
Andrew Kelvin: Certainly. And every meeting that we go, we get a little bit closer to the date of rate cuts. Now we still see this as a mid 2024 scenario. We still look for the first rate cut to occur in July. We think there will be about 100 basis points of cuts next year. Whether that starts in July or June or April, that will really depend on the path of inflation.
For the Bank of Canada to cut rates, they need to have achieved both, be well on the way to achieving their inflation target. So, they don't need to be at 2% year-over-year headline inflation, and they've said that. But they need to be extremely comfortable that they are going to get to 2%. And they need to be in a still sluggish growth environment with excess supply in the economy, of slack in the economy. Now, growth certainly sluggish. I would argue with the unemployment rate where it is, we are now back to balance in the economy.
So, if growth remains slow, as we expect it will in Q4 and in the early part of 2024, we will go into excess supply. There will be some actual slack into the economy. So, from a growth standpoint, the economy is probably weak enough for them to justify taking away a little bit of this tightening. But from inflation, you look at the underlying trend in inflation, it's sort of consistent with 3% inflation as a steady state. And that's still too high, which is why the Bank of Canada just has a little bit more work to do holding rates at these levels until we can keep inflation moving along that path to 2%.
The risk they run is if they were to cut too early and we settle at a level of inflation that is above 2%, they run the risk of having to actually reverse course sometime down the road. And I think what you absolutely do not want to see in the context of an economy with really significant mortgage resets coming in 2025 is a central bank hiking into 2025.
That would be a pretty negative scenario for the economy, just in terms of it would really lock in tight financing conditions for a lot of households for a long period of time. And it would also limit the Bank of Canada's ability to influence the economy between 2025 and 2030, as people get locked into these higher mortgage rates. And lastly, and probably most importantly from their perspective, if they start cutting too quickly, after having missed their target for as many years as--
Greg Bonnell: We're going to lose faith, right, in their ability to control their mission.
Andrew Kelvin: And ultimately that gets reflected in wage negotiations. That gets reflected in contracts with suppliers for firms. And it just builds that inflation into the system, and it makes their ultimate job that much harder. So I would make the argument that they would probably rather start cutting one or two meetings too late then cut one or two meetings too soon. They'd rather make well and sure that they are on track to 2% inflation rather than sort of risking it and moving a little bit early to let the sort of pressure off the economy a little bit.
Greg Bonnell: So now we have the last rate decision of the year from the Bank of Canada in our hands. We're able to go through it, dissect it, as we have. We still got the Fed coming up next week. Is it going to be pretty much the same story from them? Are there different factors in the States?
Andrew Kelvin: Well, I think the different factor in the States is that the US economy in the third quarter was quite robust. You actually have fairly similar market contexts, where people are looking for around the same amount of Fed cuts next year as they're looking for the BOC. It is that sort of same story that central banks are telling, central banks in developed markets, like we broadly believe they are done here, with the exception of Japan.
Now it's a question of just trying to push back on very near-term rate cut expectations, because no central bank wants to cut too early. And the Fed is always very focused on financial conditions. As yields have moved lower, financial conditions have loosened. And they wouldn't want to encourage further loosening in financial conditions. So, I think the message will be much the same. We have made progress on the inflation front. The economy was stronger in the US, however, which makes it almost a little bit easier for them to push back on near term rate cut discussions.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Why The Bank Of Canada Says The Inflation Fight May Not Be Over Yet