The Bank of Canada has raised its overnight interest rate by a full percentage point, a surprise move that boosts its effort to tackle runaway inflation. Greg Bonnell speaks with James Orlando, Director & Senior Economist, TD Bank, about the potential impact of rising rates.
- The Bank of Canada delivered a super sized-rate hike of a full percentage point today, that as it attempts to wrestle down soaring consumer costs. But what are the risks that the battle against inflation is going to push the Canadian economy into a recession? Joining us now with his view, our featured guest of the day, James Orlando, senior economist at TD Economics.
James, great to have you with us. I really want to dig into this question. We know that we're in a rising rate environment. But 100 basis points in one go-- what are the risks here?
- The risks are pretty substantial, and that's why we're hearing so much talk of recession, not just in Canada but around the world. Hiking interest rates by 1% is uncommon. The last time we had it happen was in 1998.
And if you think about what's happening right now, the way the Bank of Canada is describing everything, it's that they are using this to front-load. They're trying to get ahead of inflation knowing the fact that they're actually really far behind inflation at the moment. So it's not just that they're hiking 100 basis points today, 1%, but how much further will they be hiking in the future? What does that mean for Canadians?
- Front loading to achieve, I think, Tiff Macklem, as he was holding court, the Governor of the Bank of Canada, after the announcement came out, to try to achieve that soft landing. Is this like trying to land a rocket ship on the head of a pin?
- That's one of the analogies that's going around for sure. It's very hard. If you look back at history, high inflationary time periods, rapidly rising interest rate time periods, history is littered with time periods where those things go up and we end up in recession. Now, the issue that we're facing right now is that everyone's hoping that we get a soft landing.
And how difficult is that? So you think about what inflation means for Canadians. It effectively erodes purchasing power. So your money doesn't go as far. So when you see something go up in price for one thing, you have to adjust your spending on other things.
Now what that ends up happening for Canadians is that we actually purchase less. And as you purchase less, that means less economic growth. That feeds through to businesses. It feeds through to everyone.
Rising interest rates, what does that mean? It means that you're going to be paying more and more money on any loans you have. So whether it be your car payment, if you have a heat lock, if you're resetting your mortgage on your house, all of this has a really big impact.
And so the idea that we're going to go and we're going to go through this time period and get a soft landing, it's certainly possible. But given the fact that it's been so hard for that to happen in the past is a big problem with the Bank of Canada.
Now, as you mentioned, they're forecasting a soft landing. So they're not forecasting recession, even with everything we're talking about right now. Whether or not that happens we're going to find out, but it's going to be a tough task for the Bank of Canada to achieve that goal.
- After the decision, Tiff Macklem giving his opening remarks before taking questions on the decision they made today, and he basically said he recognizes that it might sound counterintuitive. Canadian households, we know you are struggling with soaring costs, so what we're going to do is raise the cost of borrowing for you. And he says the short-term pain is pretty key so that things don't get out of control.
How hard is that to sell to the Canadian public at this point who are dealing with just rising prices across the board?
- Yeah, I think everyone's feeling the pinch right now. As you mentioned, inflation-- it's not just a few things. So initially when inflation started ramping up, we started seeing it in energy prices. So that's one thing. And then you start seeing in food. Then you start seeing in pretty much everything that we're buying these days.
And so it's true. You're absolutely right. You have inflation broad everywhere. And then what the Bank of Canada is doing is they're going to raise interest rates, which is going to raise prices on what you're spending on your home most likely. And so it is a problem.
But the thing is that the way the Bank of Canada is phrasing it, and the way that we should all note, is that when you are trying to maintain stable prices-- like, Bank of Canada wants to avoid this from happening anymore. They want to stop inflation from keep going up. Because if they don't raise rates, the way they're doing right now, and continue to raise rates, inflation is just going to get higher and higher. And anyone who lived through the 1970s or early 1980s, when you had double-digit inflation, knows that we want to avoid that time period.
The number of people that have come up to me and talked about how their mortgage rates were 17%, 18% in the 1970s and '80s, they know. They know exactly what was going on and the threat of what it means if the Bank of Canada can't break this inflation cycle, which just keeps going up and up.
- Now, of course, we don't have our latest inflation trend, or the one we have is a bit backward-looking. We got the Americans today coming in-- their CPI print coming in at 9.1%, hotter than expected. This whole idea is like, have we seen peak inflation yet? It doesn't feel like it, at least not from the American experience.
- Well, it certainly didn't-- it hasn't shown any signs of peaking. That's for sure. In Canada, we're expecting another increase in inflation as well when that data come out.
It's one of those things where if you look at the American inflation, certainly, people-- some people have commented on the fact that core measures of inflation-- so when you strip out things like food and energy-- on a year over year basis, that's been decelerating for a little bit of time now. But you look at the overall headline inflation. You look at the fact that energy prices just don't seem to be abating. Gasoline prices haven't followed what has happened with international oil prices to the same extent. And the other factor is that all of these good prices that are still increasing at a pretty high eclipse right now, we're now seeing it's shifting into services.
So for a long period of time, we could only buy goods. Everything that was a physical thing that we always say if it dropped on your foot it was going to hurt, anything like that was going up in prices. And supply chains are still bottlenecked. We've seen some reprieve.
There's still a lot of supply disruptions going on right now. But as we shift into services, there's so much demand for all these services that we have in the economy right now that demand for that is causing inflation in that area. And one thing that you'll probably note from history is that even if you get a peak in goods inflation, service inflation peaks much later. In Canada, for example, if you look at what happened in the '70s and '80s, we had two peaks in goods inflation. But service inflation only peaked about a year after that.
HOST: When it comes-- I imagine a happy dream for a central banker. You go to sleep and you dream about the supply chain issues being resolved, conflict in Europe being resolved, inflation comes down of its own accord, and you don't have to punish us with these high borrowing costs. Obviously, that would put a smile on their face. If that doesn't happen, is all that is left-- and what we're seeing right now-- is just to crush that demand and, perhaps, push us into a recession even though they want that soft landing?
- Well, for the Bank of Canada, it's a tougher decision. So Canada is a small but open economy. So we're beholden to a lot of what's happening around the world.
We really do-- there's a little bit of inflation that is demand-driven from Canada. We know that our economy is in excess demand. But as the Bank of Canada mentioned today, the majority of the inflation miss, so relative to their forecast, is due to external supply-driven stuff.
And so you actually need that to turn. So if that doesn't turn, the ability for the Bank of Canada to get inflation to come back down to target, it's incredibly challenging. You don't have that capacity to do that. Because if you don't have that, most of our inflation right now is coming from abroad. So you actually need that global slowdown.
And so it's not just energy, what's happening in Russia and Ukraine. But it's also what's the coordination of central banks. And so the good news is that we do see coordination from lots of central banks, specifically the Fed, which is the central banker to the world. And when they raise interest rates, that has an impact on everyone.
When the Bank of Canada raises interest rates, it has an impact on Canadians, but it's not going to transfer through. So we really do need to see not just a lot of things resolve around the world-- bottlenecks, commodity price issues. But we really do need to see a slowing of demand globally.
And we're getting a little bit of that right now. US growth hasn't been very impressive for the last two quarters. Chinese demand has fallen, given the COVID lockdowns that they have had. So you're starting to see that, and that's playing through in commodity prices. But you need to see much more of that going forwards for you to actually get inflation back down to target.
And if you look at what the Bank of Canada inflation forecast is showing, they actually don't think inflation is going to get back down to target this year, not next year, but in 2024. That's a long time to wait for inflation to come back down to what we call comfortable levels or back down to target.
- That's a great lead-in to another question I have on my mind. What about the suggestion-- and it seems to be coming from the bond market-- that, yes, we're going to see these rapid hikes and they're going to come fast and furious and they're going to be super sized, but in short order, we're going to be talking about rate cuts again? Is that a little too optimistic, perhaps, for an investor who's thinking, OK, there's going to be some pain in the short term, but in not too long we're going to be talking about cuts?
- Well, I think that's exactly what the Bank of Canada is doing and the Federal Reserve as well. So if you look at-- you're talking about the OAS yield curve for future interest rate hikes. Any time a Central Bank says they're going to raise rates to a level to restrict economic growth, that means they're going to get rates higher than they typically would in the future. And then once they actually get that turn in inflation they're looking for, they can bring rates back down to what we call a neutral level, so a level that's not going to stoke nor choke off demand for the economy.
And this is very normal. But what you're seeing in the bond market is you're seeing that factor, is that over the next two years, the Bank of Canada Federal Reserve, they're going to raise the rates a lot. And when they raise rates a lot, they're going to be higher than they are going to be in the long-term.
And that causes what we call yield curve inversion, where there's inversion where the two-year yield is higher than the 10-year yield. And most people that study these graphs know that that is a pretty big harbinger for recession. So people are watching that.
And that's why the recession talks are also happening a lot because they're expecting that they're going to go too far. They're going to restrict economic growth. But they're going to have to pull back from that at some point in time.