Bank of Canada’s Surprise on Interest Rates Is Test of Soft-Landing Bets


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(Bloomberg) — Canada’s Tiff Macklem was the first Group of Seven central banker to adopt outsize rate hikes to tame runaway inflation, saying that big increases would boost the odds of a soft landing later on. Now his argument is being put to the test.

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After raising its overnight lending rate to 4.5%, a 15-year high, the Bank of Canada said Wednesday it expects to hold until it can see how Canada’s economy and its heavily indebted consumers are dealing with elevated borrowing costs. “We know it takes time for higher interest rates to work through the economy to slow demand and reduce inflation,” Macklem said.

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The rate-pause signal is another surprise from Macklem, one accompanied by a new central bank projection that says inflation will fall quickly, from 6.3% to about 3% by midyear, with a mild economic contraction at worst. It’s even possible that Canada could skate through this rate cycle with no recession at all.

In doing so, Macklem, 61, has clearly put his reputation on the line. If he’s wrong about a soft landing — if inflation stays stubbornly high, or if the economy tumbles into a deep recession — it will be the central bank’s second major forecast error in his less than three years in the job. He’s already scorned by some Canadians for his actions during the pandemic, when he assured rates would stay low for a long time, prompting some to take on jumbo variable-rate mortgages to buy homes that are now dropping in value.

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“The path for the mythical soft landing is pretty narrow,” said Sebastien Page, head of global multi-asset investing at T. Rowe Price Associates Inc.

Conditional on Data

Macklem and his governing council raised the overnight lending rate by a quarter percentage point on Wednesday, but markets were fixated on the decision to stop there. Officials say the rate pause is conditional on economic data “evolving broadly in line” with the central bank’s Goldilocks scenario — a return to 2% inflation by the end of 2024 and two or three quarters of stalled growth, without a major increase to unemployment.

Forward guidance — outlining the bank’s future rate plan — has been a favored tool of Macklem’s since he became governor in June 2020, a job he had long coveted but was previously denied. 

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Early on, he hinted rates might not rise until 2023. “Our message to Canadians is that interest rates are very low and they are going to be there for a long time,” he said at one of his first press conferences as governor. 

Soon, an overheated labor market and soaring prices prompted him to break his word, as he quickly hiked rates from an emergency low of 0.25%. His credibility came under a cloud after the about face.

‘Explicit Guidance’

Some analysts say the Bank of Canada’s willingness to risk another reputational hit adds weight to its new projections.

“I have to believe they have a higher-than-normal conviction with their forecasts moving forward, to be this comfortable giving such explicit forward guidance,” said Andrew Kelvin, chief Canada strategist with TD Securities. “But I don’t know that I’d be so keen sending declarative messages to the Canadian public.”

Markets seem to agree with the central bank’s assessment of the economy. Swaps pricing suggests that traders believe it will stick to its commitment to hold rates steady for a while, and two-year Canada bond yields have tumbled from around 4.3% to 3.57%. That’s 55 basis points below comparable US Treasuries; as recently as September, Canada two-years paid a higher yield. 

To be sure, policy makers hedged their statement, saying they’re prepared to increase rates further if needed.

“We do have to be humble,” Macklem told reporters. “There are a number of risks out there.”


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