Former parliamentary budget officer Kevin Page warns that interest rates will go up until inflation comes down:
The governor of the Bank of Canada, Tiff Macklem, has announced the third rate hike in four months. The interest rate tightening cycle is maturing quickly. The policy rate (the overnight lending rate to banks that is used as a benchmark for household and business lending rates) now stands at 1.5 percent — up 50 basis points since April 13; up 100 basis points since March 2; up 125 basis points since January 26. It is a steep climb. There is a lot more climbing to do. Economy beware.
The reasons why inflation is a problem are complicated:
The consumer price index is up 6.8 percent on a year-over-year basis. It is more than twice the upper end of the Bank of Canada target range of 1 to 3 percent.It is a good bet that this inflation rate will increase in the months ahead. We have seen strong monthly increases in 2022, particularly since the start of Russia’s invasion of Ukraine on February 24. There are significant price pressures at the industry and commodity level that are yet to pass through. This is a global issue. Contrary to the initial assessment of Fed Chair Jerome Powell in 2021, it is not transitory.
Two large supply shocks stemming from the COVID public health crisis and the Russia-Ukraine war. COVID-related supply restrictions continue in large economies, including China. The latest global surge in oil, metals and grain prices can be tied to the repercussions of war. These supply shocks are enduring.
But, most importantly, the economy is rebounding quickly:
Inflation is being pulled upwards by a stronger-than-expected rebound of demand in the economy, in Canada and elsewhere. In 2020, facing significant uncertainty about the human impacts from the virus (both in spread and fatalities), policymakers boosted household and business balance sheets. As social restrictions lifted, the economy surged forward. Higher demand means higher prices as supply struggles to keep up. We saw this with the prices of goods in the early phase of the pandemic. We are seeing it now with services.
It is possible, perhaps likely, we could see four more policy rate increases this year, including another possible 50-basis point (large) hike in July. The Bank of Canada says the normalized policy interest rate is in the 2 to 3 percent range. That is an interest rate consistent with a stable rate of inflation in the 2 percent range and an economy growing at its potential. With tight labour markets and a rate of inflation well above target, a 3 percent policy rate could be too low to bend future inflation rates downward. This suggests we could be less than halfway in the interest rate hiking cycle.
So hold onto your hats. When interest rates go up this quickly, there's usually a crash in the not-too-distant future.
Image: Business Insider