Rising rates

Higher rates needed and for longer than most expected

When he put a “pause” in January on the most aggressive interestrate-hiking campaign in the history of the Bank of Canada, the bank’s governor, Tiff Macklem, was hoping that inflation would continue its downward path without much if any further monetary intervention.

But in breaking that long pause this week with a further quarterpoint rate hike, the BoC has shown that it is guided not by wishful thinking but by facts on the ground.

Which are, in a nutshell, that the Canadian economy is strikingly resilient despite historically high interest rates and inflation.

And that means higher interest rates will be required, and for a longer period, than most economists and the BoC expected to further reduce inflation.

The BoC, with a big assist from spending restraint by Canadians and by Ottawa, has succeeded in slowing the economy enough to cut the inflation rate by half, to its most recent reported 4.4 per cent in April from an 8.1 per cent peak last summer.

But in April, inflation ticked back up. It isn’t the size of the increase but the direction that is worrisome. Inflation appears to be on the rise again.

And never mind some evidence that inflation fell in May, the numbers for which will be reported in coming days.

The central bank was also troubled by later reports, in May, on Canada’s economic performance in the first quarter, which was outstanding and beat all expectations.

As welcome as a robust economy is, it can also warn of a resumption of rising inflation, which reduces the purchasing power of the Canadian dollar.

The evidence for that troubling possibility is so strong that the BoC was obliged this week to come off the sidelines with its further 0.25 per cent hike in its benchmark interest rate, bringing it to 4.75 per cent.

That makes for a 19-fold increase in interest rates since the BoC began its inflation-fighting campaign in March 2022.

The first quarter of this year saw the Canadian economy rebound in almost every meaningful way.

Consumer spending, close to flat in the two previous quarters, roared back with a vengeance, posting an extraordinary 5.7 per cent annualized gain.

And that spending was on goods as well as services, after a long spell of tepid goods spending.

The quarter saw Canadians increase their purchases of cars, clothing and other goods, with continued high spending on services, notably big-ticket outlays on travel.

Meanwhile, the labour market has remained tight, though it’s showing signs of cooling, with Statistics Canada reporting Friday that 17,000 jobs were lost in May, the first time in nine months there was a net job loss. The unemployment rate rose for the first time since last August, to 5.2 per cent.

Impressive wage gains made by federal workers in the settlement that ended their strike last month have put upward, and inflationary, pressure on wage settlements elsewhere in the economy.

Exports were up 10.1 per cent in the first quarter on increased international demand for Canadian autos, metals and agricultural products.

At about nine per cent, food inflation remains intolerably high, running far ahead of the general inflation rate.

And GTA house prices have been on the rebound, after an all-too brief respite from bidding wars.

If this is the buoyancy of the Canadian economy during a slowdown, including a hostile political relationship with trading partner China, the prospects for curbing inflation when normality returns are not especially favourable.

Hence this week’s rate hike, with at least one more rate increase to come next month if inflation stubbornly refuses to resume its downward trajectory.

For the record, the BoC is aiming for a 2023 average inflation rate of three per cent, and 2.3 per cent next year.

There seemed to be faint hope of achieving those targets unless the BoC acted sooner than expected in resuming its rate hiking cycle.

Derek Holt, an economist at the Bank of Nova Scotia, warned earlier than most that the BoC would have to raise rates soon or risk inflicting on Canadians the possibility of runaway inflation.

“If the BoC doesn’t adopt the crush it, killer mentality,” Holt wrote in a client note back in midMay, “then it may never succeed in getting inflation down to two per cent.”

The BoC’s credibility was also at stake.

In its own surveys of consumers and businesses, the BoC has reported that most Canadians do not think it can achieve its inflation reduction targets.

And that risks entrenched inflationary expectations, in which inflation feeds on itself with people buying ahead of expected future price hikes.

That makes still higher inflation a self-fulfilling prophecy.

Those risks were diminished this week. The BoC’s latest rate hike proves it is walking the talk of its repeated vows to raise rates if facts on the ground show insufficient progress in curbing inflation.

It’s good to see Macklem back in the fight.