Ben Tal on Bank of Canada rate hikes

There is a strong case to be made that the Bank of Canada has raised rates too high. This is according to CIBC Deputy Chief Economist Ben Tal, who says the bank’s job now is to “manage volume overshoot”. The Bank of Canada has now raised the key lending rate by a whopping 475 basis points, or 4.75 percentage points, since last March. This represents the fastest pace of increases in Canadian history. In a recent research note, Tal says the bank chose to err on the side of too many rather than too few increases for one simple reason: its bias toward anti-inflation. He goes on to explain that the Bank of Canada faces two options, one is continued high inflation if interest rates do not quell excess demand in the economy, or recession if rates get too high and end up reversing economic growth. “The bank is going to have a recession any day,” Tal points out, because central banks have many tools and a lot of experience in dealing with recessions. On the other hand, out-of-control inflation expectations “are a central bank’s worst nightmare.” At this point in the rate-raising cycle, Tull argues that for every positive or “bullish” economic indicator indicating economic strength, there is another equally negative or “bearish” indicator. “But given bank bias, more weight is given to strong indicators,” he writes. Bank of Canada ‘optimistic’ despite counterinflationary signs One example of this is the bank’s recently updated GDP growth forecast. In its latest monetary policy report, it said that GDP is expected to grow by 1.8% in 2023 year-on-year (up from a previous forecast of 1.4%). However, Tull suggests that the revised outlook is “strategic positioning,” and will “limit [Bank’s] Likewise, the Bank’s revised CPI inflation forecast back to its 2% target by mid-2025 “is simply buying time with limited risk of increasing long-term inflation expectations.” “This is a good move,” Tull suggests. “Buying time would allow the Bank to be less reactive to the current/near-term strong numbers while allowing time for some important deflationary forces.” Those deflationary forces include improvements in supply chain conditions, which have the effect of reducing gross margins for retailers, which Tull calls it “an undervalued disinflationary force on both sides of the border.” He also notes that the labor market may not be as tight as it seems due to an undercutting of the labor supply by the “dramatic cut” of non-permanent residents in Statistics Canada’s employment data. Will the Bank hike again in September? September, with odds currently at 80%. Tal notes that the bank may continue to push deeper into “overshoot” territory, but adds that the impact of its past rate hikes will be felt more widely soon. He writes: “The Bank of Canada may rise again in September, but very soon it will be noticeable to ignore the current deflationary forces, even for a biased bank.”

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