Much has been written questioning policy decisions made by the Bank of Canada, especially during and after the pandemic. Beata Caranci, Chief Economist at TD Bank, speaks about the lessons learned and what it means for monetary policy going forward.
TD Economics has just come out with report called "The Bank of Canada-- to Err is Human, to Forgive is Divine, and to Evolve is Necessary." Here to give us some perspective on the latest report and what it means for Bank of Canada outlook-- Beata Caranci, Chief Economist at TD Bank. OK, this report is fascinating.
And I feel like I've given the title of the report. But there's a piece at the bottom, I think, that's pretty important. There's a quote that the Bank of Canada Governor Tiff Macklem came out and talked about in October of 2020.
It's longer, but the crux of it is you can be confident that interest rates will be low for a long time. Tell me about why you wrote this. What was the reason to talk about that statement, their outlook, and the impact that it had?
Yeah. It really was-- that quote is getting a lot of circulation in terms of just chatter, markets talking about it, media citing it. And so I said, listen. You have to remember, at that time, we were entering another COVID wave.
Even vaccines had not been approved at that stage. Inflation was less than 1%. And so really, what they were trying to do was shore up confidence-- that we've-got-your-back-type statement.
And it was like, let's forgive that statement. You have to take it for what it was in that moment. What the error was for the Bank of Canada, and why I wanted to write that, was because it wasn't that they made that statement. It's they never evolved their guidance or thought.
So they demonstrated-- which is a very common pitfall in forecasting among economists and analysts. When you anchor your views, you get stuck in a precondition that existed, or past rules, or past analysis you've done. And you're not really evolving to how the data is moving, or whether there's been changes occurring in the economy-- structural changes, cyclical, that you need to pay attention to and adapt to.
And so they didn't have the adaptive thought as we were moving through the pandemic. And so by mid-2021, it was very clear that the data had done much better than everybody had expected. But they never moved off that position. And it's a question of, why didn't you move off that position when the data was overwhelming?
There's some very real-world implications. And you and I were just talking about the fact that while the US has gone through a deleveraging cycle, Canada has gone through a releveraging cycle. And to quote your report-- don't you love when people quote your own numbers back at you?
But it's fascinating. "The share of variable interest rate mortgages originations increased from 6% before the pandemic to 56% in the 4th quarter of 2019." Again, just human nature. If I get a low rate, I'm going to refinance at a low rate, and now we're vulnerable-- or take on more debt, I should say, at a low rate. So it had real-world implications.
Yes. And typically, when you think of a central bank, and their mandate is really to monitor inflation and create that stability around it, often, when you think through how they think about housing market risks, it's not part of their official mandate. It's often treated as a byproduct of interest rate cycles left more towards the regulators to manage. However, when you're leaving interest rates for a very long period at zero, effectively-- which they did for about eight quarters--
And everyone did before that.
Yeah. And you become the main catalyst for why people are behaving in a certain way in the housing market. There is some responsibility to have to respond to that and take rates off the floor, in my opinion.
And so I think that this was a very clear signal that the financial risks were migrating and tilting the balance away from staying at 0 is the safest thing you can do because we want to get inflation off the ground. And even the Bank of Canada's own research had shown that households do adjust their inflation expectations based on where home prices are going. And so there is a correlation there that just needed to be refined in their thinking.
So we've got a couple of minutes just to say, you've got a great line in the report saying "should have, would have, could have." Anyway, it's done.
This is where we're at. So what does this mean for Canada in 2023?
Yeah. So we're on the other side of it, right? [LAUGHS] So that forward guidance has literally flipped to an oops, which is, I think-- to the credit of the Bank of Canada, they've said, yeah. That was a mistake in the timing of coming off the zero, not having gone there, but just having left it too long.
And so we're on the other side of this rapid escalation in interest rates, and in the context of now having these financial risks related to the housing market. And so this is why I think that Canada is more at risk of a slower economic cycle or a slow recovery on the back end of it because we have to go through some sort of deleveraging cycle. And that naturally means that you're stealing growth away from other parts of the economy where your money would have went towards, so spending in other areas of consumption.
So there will be a longer-term effect. And when we've looked internationally at other countries that have gone through deleveraging cycles, they tend to be multiyear events. So it would be remarkable if we get out of this completely unscathed because of that.
I've only got about a minute here, but when you take a look at the interest rate outlook for the Bank of Canada at this point, then, assuming, again, the oops has happened and we're now looking forward to what they might be doing from here on in, what do you see? Are rates higher for longer?
Yeah. So this again-- so right now they're giving the guidance that they have an intention to leave rates elevated for a period of time because they're focused on making sure financial conditions don't loosen too quickly, and behaviors come back in that they're trying to avoid. Our view is when you actually look at the risks related to interest rates and the mortgage leverage, it would be unusual for us for them to see interest rates holding at this level as we get towards the end of this year because every quarter that goes by, more and more people will be renewing their mortgages at much higher interest rates than they did five years ago.
And then you have this variable interest rate mortgage component happening as well, where it's a bit more instantaneous. So that compounded effect is why we have the Canadian economic outlook lower than what we have in the US, simply because there are certain dynamics here that are unique to us, not them. So we think there's an opportunity for them to put some relief back in as household strain continues to build as the year goes on.
It does not mean that we think that interest rates are going to be going back to 0%, or 1%, or even 2% by the end of the year. We just think they could come off of what-- our view is they'll get to about 4.5%, come back down to hopefully around 3.5%. It's still restrictive in terms of a higher level of interest rates relative to the past, but it takes some of the pressure on the financial side off of households. That could lead to more difficult dynamics, like harder landing dynamics if it extends into 2024 as more and more of those mortgages continue to renew. [AUDIO LOGO]