However, the central bank's renewed mandate seems to be at odds with market realities
Despite the Bank of Canada’s focus on seeking the level of maximum sustainable employment needed to keep inflation on target, it’s unlikely that labour market performance will be the deciding element in the timing of the central bank’s first rate hike, according to Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce.
Shenfeld described the BoC’s new mandate as “a case of old wine in new bottles,” as it essentially repackaged the 2% inflation target into a policy that emphasizes “features of that approach that, to a significant degree, were already inherent in it.”
“The prior mandate, while described under the rubric of ‘flexible inflation targeting,’ was never acutely driven by short-term fluctuations in the [consumer price index], and had allowed for overshoots and undershoots when these were being driven by factors other than too little or too much economic slack,” Shenfeld said. “The Bank of Canada has emphasized the output gap as the driver for sustained inflation trends, and in effect, aimed to have the economy running with a zero output gap (GDP right at its non-inflationary potential) in order to achieve the 2% CPI target.”
Read more: Bank of Canada announces inflation target
However, Shenfeld said that this approach seems to be at odds with the latest labour market data, which showed that the nation’s jobless rate is now hovering “within a few ticks” of the prior cycle’s low point.
“The employment rate, which also takes labour force participation into account, has also seen a full recovery,” Shenfeld said. “Inflation, including core measures, is now over the midpoint of the target range. Indeed, it's in real GDP measures, rather than in the temperature of the labour market or inflation, where there is still a shortfall. That GDP gap, and concerns over the near-term drag from the latest COVID wave, is the reason why the central bank hasn’t already raised rates.”
These are the reasons why employment will not be the decisive factor in the central bank’s decision to begin raising rates, Shenfeld said.
“Central banks would typically move off the maximal degree of monetary policy stimulus ahead of full employment, in order to avoid shooting through its target, as there are lags in the economy’s response to rate hikes,” Shenfeld said. “Since ‘full employment’ is a judgement call that has to depend on watching for signs of unsustainable wage inflation, policy makers have to reduce stimulus early to have the luxury of hiking gradually and letting the data provide the signals for when the labour market is at its capacity.”
According to CIBC, the market is pricing-in a "fairly aggressive pace" for the BoC's 2022 rate hike cycle. CIBC is forecasting a total of 75 bps in hikes next year, beginning with a modest 25 bps initial increase in April.
