The Bank of Canada signals the end of speculative excess

The Bank of Canada (BOC) has started tightening monetary policy, with a 50 basis points hike this week.

This is the end of the easy money policy that has been in place since the 1990s.

Will this tightening burst the speculative bubbles in Canada?

Here is the announcement and a link to the press conference if you want to read body language.

 

Bank of Canada Governor Tiff Macklem. Source: Bank of Canada

 

The BOC also announced that their policy of buying government bonds and mortgages will end this month.

Monetary policy is still easy if interest rates are below the rate of inflation. Inflation, as measured by the CPI is about 8.5 percent in the U.S. and probably more than 6 percent in Canada. (The CPI number comes out next week)

The hike brings the BOC’s official rate to 1 percent and the banks swiftly adjusted their prime rates higher by 50 basis points to 3.20 percent. Mortgage rates, currently 3.5 to 4.0 percent for a fixed rate loan, will also move higher but these rates are still below the rate of inflation.

If mortgage rates went up by 100 basis points, young couples would qualify for significantly smaller borrowing and much less buying power.

For real tightening to occur rates would have to be pushed even higher, above the rate of inflation, as happened in the early 1980s, and the central bank would have to aggressively reduce its holdings of mortgages and government debt by selling those bonds into the market.

At the same time the BOC is downgrading its forecast for economic growth. The current year will see 4.25 percent with next year slowing to 3.25 and then 2.25 in 2024. Key phrases in the release are “Higher interest rates should moderate growth in domestic demand” and “housing market activity … is expected to moderate”. Sounds like there will be a lot of moderation!

The very high rate of inflation is their main concern, and they blame Canada’s CPI on energy, food, supply disruptions and increased expectations of higher inflation.

Then the BOC gets to the main point: “The bank will use its monetary tools to return inflation to target and keep inflation expectations well-anchored.”

As has been discussed before, the BOC will have to use its monetary tools to trigger a recession before they can expect inflation to “moderate”. Inflationary expectations are known to be very entrenched once people see prices rising for any long period. House prices have been rising at 7 percent per year for more than two decades. Food prices and energy prices have been rising rapidly recently.

A few rate hikes of 50 basis points will not be enough to break those expectations.

Watch for signs that the BOC and Governor Macklem are faltering in their resolve, as the economy slows and enters recession, and house prices begin to fall.

It is far from certain that they will stick to their guns long enough to burst the speculative bubbles that dominate the Canadian economy.

 

Hilliard MacBeth

 

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