The Bank of Canada raised its benchmark interest rate to 4.75% amid concerns about strong growth and high inflation. Greg Bonnell speaks with Andrew Kelvin, Chief Canada Strategist at TD Securities, about the surprise hike, the BOC’s potential next move and the economic implications.
- Well, the Bank of Canada has surprised the markets, raising its trendsetting rate by another quarter of a point. They say they have concerns, that concerns out there are growing, and inflation is going to get stuck above target.
Joining us now with more, Andrew Kelvin, Chief Canada Strategist with TD Securities. Andrew, right off the top, I want to say, you and I were chatting with this yesterday afternoon ahead of the decision, ahead of the show. And you're saying, I know there's a hike. There's a hike coming. So kudos to you for calling this one because it was a bit of a coin toss. Why did we get this hike today?
- Thank you. There were some nervy moments this morning for me, certainly.
GREG: You were definite?
- So I think the best way to explain this is to go back to January when the pause was first announced from the Bank of Canada. At the time, the Bank of Canada was looking for GDP growth at about 1%. For 2023, they were talking about flirting for a recession. Inflation was expected to get down to sort of the mid-twos by the fourth quarter of this year.
As of the most recent data we've seen on the TD Securities side, we're looking for growth to be sort of 1.5%, 1.6% this year. That's quite a big deviation from where the bank originally saw the economy when they announced their pause. We don't think inflation will get below 3% this year. In that sort of a world, it became very difficult to justify that on-hold stance the bank had announced all the way back in January.
If we go to April, the bank was very open that they had discussed lifting rates in April. And that was with the uncertainty around the US banking issues, let's call them. Since then, all we've had our upside surprises in GDP, upside surprises on inflation, and upside surprises on employment. In a world where you weren't going to hike because the economy was going to slow, and then the economy didn't slow, it just follows up, they had to hike. And here we are today.
- Very specific concerns today. Of course, we didn't get a media availability with Tiff Macklem and his senior deputy governor that could explain their move today. All they had was that piece of paper, where they did outline some concerns. It was GDP, talking about inflation.
And one line that really stuck out to me was saying there was growing concern that they're hearing about at the bank that perhaps inflation isn't going to get back to target unless they take further moves. What do you think has shifted for them? Because I feel like the last time we heard them speak on the issue, they said, one month doesn't a trend make. And suddenly it's like, no, there's concerns out there.
- I mean, one month doesn't a trend make. But it's been four, five, six months with quite high interest rates where the economy did not slow. The unemployment rate has been 5% for all of this year, despite that very tight monetary policy.
The bank's sort of framework for thinking about this is to bring inflation lower, they need to slow demand in the economy. There were some reasonable concerns in January that, given that there are lagged impacts of rate hikes, and given the very high degree of household leverage in Canada, that the rate hikes that are already in place would, in the second quarter of this year, the third quarter of this year, start having really significant negative impacts on household spending.
What we've seen over the first half of the year-- it's not quite the first half of the year, but we're getting pretty close to the midway point-- has been just really tremendous resilience from the household. They weren't lifting rates to the point where they're trying to make household spending slow down. They now see with the benefit of hindsight that perhaps they did not lift rates enough to accomplish that goal.
- Now, this takes us to what happens next. You were thinking today they'd go 25. Do they go 25 again at the next meeting?
- I do think so. A single 25-basis-point rate hike when restarting the cycle would be historically a pretty rare thing. I can find examples for it. If you look at 2007, the Bank of Canada hiked just once in July. But the world changed pretty dramatically between July and September that year.
If the world changes dramatically again, the Bank of Canada can reverse course. But the momentum in the economy is such that a single 25-basis-point move is not going to steer growth comfortably back to a below-trend level.
And that's what they're trying to do. They're not trying to engineer a hard landing. They don't hate Canadians. They're trying to slow growth in sort of a gentler fashion. But 25 basis points probably isn't going to do that. So unless they see something changes in the world or they see an indication that, in fact, they didn't need to make that move, because growth slows really dramatically or inflation decelerates more than expected, then they can change tack. But as it stands, the strength of the economy has been such that 25 basis points probably just isn't going to be enough to really change the course of the economy.
- Now of course, in the past, when the housing market has been accelerating to the upside in terms of volume and price, different central bank governors-- I'm thinking of Governor Poloz before Tiff Macklem-- would say, listen, we have to worry about the broader economy. We have one lever to pull. We can't worry about the housing market.
They did make mention of the housing market today, saying we have seen spending on interest-sensitive goods increase. This is not supposed to happen when you raise rates this aggressively. Interest-sensitive goods are supposed to be shunned. And housing market activity is picking up. They definitely have to keep that on their radar.
ANDREW KELVIN: They do, as much as they don't want to be driven solely by what happens in the housing market. And I think a lot of the times Canadians are very reductive about how we think about the economy. We tend to look at house prices as our one indicator for is the economy doing well or not. And the Bank of Canada needs to think of a broader picture than that. At the same time, it's a big enough part of the economy, they can't ignore it.
And this, I think, comes back to this idea that, in January, they were concerned that some of the rate hikes already in place would have a slowing impact, a dramatic impact on the economy. And in fact, as you note, the housing market's been doing just fine. This is a supply and demand issue to some extent.
And it's not just housing. I think the same dynamic's present in the auto sector as well. On the housing side, we have this very strong population growth. And Canada is really, really good at bringing in people and growing the population. We are rather less good at building houses for that increased population. When demand increases faster than supply, prices go up. That's how it's supposed to work.
And on the auto sector side, we have continued to see below-trend automotive production. And when people come to this country, they need three things. You know, they need food in their belly, a roof over their head, and they need a way to get around.
So we haven't been building enough cars for the population in North America for the last two years. I think it follows that we should see continued strong spending on things like motor vehicles as a way of-- even if supply chains are healed, there's still an overhanging demand for some of the items that were impacted by the supply chain disruptions.
So I think there are these supply and demand factors still impacting things. And as much as the Bank of Canada can't control these things, they have one job. That job is 2% inflation, and they have one tool. So they have to use it.
- Some of the things they can't control-- I found this interesting. Near the end of the statement where they're saying, we took this action today, because we felt this is a prudent course to get inflation back down, come off the sidelines. They talk about, going forward, they're going to evaluate things. Of course, that's what they do. They're going to evaluate this excess demand, inflation expectations, wage growth. I've heard all these things before.
Corporate pricing behavior, they threw into the basket. Is there something they're worried about there? I mean, it goes back to inflation. This is prices that are being set by the private sector that we're paying for food or goods.
- I think there's a little bit of messaging that they're trying to get their head around because I think a lot of the times, if I put my economist hat on, I think of corporate pricing decisions as like, that's just part and parcel of inflation. When demand's up, corporate pricing power increases and inflation results. The Bank of Canada came under some criticism a little while ago for being focused on wages and not corporate profits.
And that was always a bit of a false dichotomy from the Bank of Canada's perspective. I don't think they recognized how that necessarily sounded to some segments of the population. So I think this is simply just the Bank of Canada acknowledging--
- You're making too much money. Don't worry about what you're paying for things. It's your problem. You're the problem here. You're making too much money.
- And we saw those running-- the articles running in the media to that effect. And I think the Bank of Canada was just a little bit sensitive to that criticism. And they're trying to be-- this goes back to a broader effort the Bank of Canada has to try and better explain what they do to Canadians. And then when Canadians notice, they get the feedback that we don't like that you're focused on wages. Why aren't we talking about corporate profits? And the Bank of Canada is just, they're not changing the way they think about the economy. They're unpacking the assumptions that were already incorporated in their models there.