BMO chief economist lays out the central bank's possible next steps
The Bank of Canada’s concerns over sticky core inflation mean it’s keeping future rate hikes on the table – but a prolonged rate hold remains its likeliest course of action, according to Bank of Montreal (BMO) chief economist Doug Porter (pictured).
In its latest decision on interest rates, released on Wednesday, the central bank emphasized that its preferred measures of core inflation are showing “little downward momentum,” and that its near-term inflation expectations are taking some time to normalize.
Several bond yields ticked upwards in the wake of that announcement, but markets on the whole seem confident that the Bank intends to leave rates unchanged for the foreseeable future.
“The main message [the Bank] got across is that the improvement in inflation is just not fast enough and they’ve got to leave open the possibility of more rate hikes,” Porter told Canadian Mortgage Professional. “I, and it seems the market, believe that they’re likely to stay on hold for quite a spell here.
“I think it’s going to take a lot to get them to hike rates again, and of course by the same token it’s going to take probably even more to get them to cut in the next six months.”
The Bank’s cautionary tone on the prospect of further hikes was unsurprising, according to Porter, given its desire to avoid stoking up the economy and potentially aggravating inflation once again.
“I came into this assuming that they can keep rates unchanged and also send the signal that they’re prepared to do more if necessary,” he said. “In other words: not let the market rally a lot thinking that rates are going to come down anytime soon. And on that front, it was mostly mission accomplished.”
Is the Bank of Canada becoming more pessimistic on inflation?
The central bank now believes that inflation will average around the 3.5% mark throughout the middle of 2024 before ticking downwards to 2% the following year.
That estimate for next year is a full half-point above its July projection, an adjustment that Porter said reflects its hawkish message and frustration that underlying inflation isn’t falling at a brisk enough pace.
Persistent inflation at the level now envisaged by the Bank of Canada for 2024 would be “disappointing,” he added. “If it averages 3% or even a bit higher next year, that’s clearly outside of their target range for too long,” he said. “It’s no wonder why [Bank governor Tiff Macklem] is still talking such a tough game if that’s what they truly believe.”
Despite lingering uncertainty over the central bank’s path ahead on interest rates, leading banks – including BMO – continue to expect rate cuts at some point in 2024.
At Wednesday’s press conference following the Bank’s announcement, Macklem did not confirm that inflation would have to squarely hit its 2% target before he would consider lowering rates.
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For Porter, that indicated the central bank could be prepared to introduce mild rate cuts in the second half of 2024 even if inflation is above that target mark.
“If they think it’s in the direction of 2%, that would probably be enough for them,” he said. “I believe that the first number would have to be a two, though. It would have to be below 3% before they would cut interest rates.
“It’s not impossible – they could do it if inflation was at 3.1%, 3.2% if they were absolutely convinced that it was poised to move considerably lower – but I would suspect that they would have to see a number of months in the high twos before they would consider cutting interest rates.”
Inflation pressures easing – but risks rising
Still, the Bank struck something of a contradictory tone in its Wednesday statement and monetary policy report, highlighting higher inflation risks compared with July despite the fact that the economy is slowing and inflation pressures are easing.
Higher-than-expected oil prices since the summer were a chief contributor to that heightened risk, in addition to persistent core inflation. For now, those factors mean rate cuts are still a distant prospect, according to Porter.
“I think maybe that’s the key takeaway today: if we take them completely at face value, the Bank is extremely concerned about inflation, and has definitely not shut the door on possible further rate hikes.
“And I think that’s the reality for the next six months. I think it’s really premature to be talking about rate cuts when the Bank is still biased to hike more.”
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