–Governor Macklem: ‘We Are Taking Our Decisions One Meeting at a Time’
–Macklem: If Inflation Continues to Ease Gradually, Any Further Rate Cuts Would be Also Gradual
–Macklem: Canadian Economy Likely to Show Soft Landing Despite High Mortgage Costs
–Macklem: There Are Limits to How Far BoC Can Diverge From Fed But We Are Not Close to Those Limits
By Max Sato
It is the first interest rate cut by the bank since March 2020 but the latest move is a different type of a rate relief compared to three emergency rate reductions, from 1.75% to 0.25%, at the early phase of the pandemic when demand plunged across the world.
At the same time, the bank said it is continuing its policy of quantitative tightening to trim the bank’s balance sheet to a normal level. The process is likely to end sometime next year when the bank will resume normal purchases of government bonds, Governor Tiff Macklem told a news conference, sticking to the official outlook.
“With the policy rate at 4.75(%), monetary policy remains restrictive,” Macklem said. “In fact, with inflation 2.7% and underlying inflation roughly in 3 and 3.25%, we still need restrictive monetary policy. There is still some work to do to get inflation back to target.” In that sense, the bank needs to “continue QT” and “continue to normalize the balance sheet.”
“If we were to lower the interest rates so much that we are actually trying to provide stimulus to the economy, that would be a different situation, and in that situation, we probably would stop QT, then they wouldn’t be working cross purposes. But that’s not a situation we are in now,” he explained.
In its previous policy announcement on April 10, the bank maintained the key rate at 5% for the sixth straight meeting, with bank officials saying they needed to see clearer evidence that inflation was on its way down to their 2% target before lowering the rate from the restrictive level.
“With continued evidence that underlying inflation is easing, Governing Council agreed that monetary policy no longer needs to be as restrictive and reduced the policy interest rate by 25 basis points,” the bank said in its latest statement.
“Recent data has increased our confidence that inflation will continue to move towards the 2% target. Nonetheless, risks to the inflation outlook remain,” it said.
The bank repeated its recent statements: “Governing Council is closely watching the evolution of core inflation and remains particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”
In his opening remarks at a news conference, Governor Macklem said, “If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate. But we are taking our interest rate decisions one meeting at a time.”
Asked more than once whether the bank will cut its policy rate again in the July 24 policy announcement, Macklem remained tight-lipped, repeating his comment that the bank’s policymakers are “taking our decisions one meeting at a time.” He also said, “Let’s just enjoy the moment for a bit.”
The governor himself may not have a clear idea at this point as to when the bank can lower the rate further. “The timing of any further cuts is going to depend on the incoming data,” he stressed. “In particular, it is going to depend on what those incoming data tell us the most likely future path for inflation.”
He did say, however, that if the pace of easing inflation remains “gradual,” the pace of any future rate cuts would also be “gradual,” in sharp contrast to the 10 rate hikes totaling 475 basis points (4.75 percentage points) that the bank conducted between March 2022 and July 2023, taking the overnight rate to a 22-year high of 5% from its record low of 0.25%.
“We don’t want monetary policy to be more restrictive than it needs to be to get inflation back to target,” the governor said. “But if we lower our policy interest rate too quickly, we could jeopardize the progress we’ve made.”
The governor warned: “Further progress in bringing down inflation is likely to be uneven and risks remain. Inflation could be higher if global tensions escalate, if house prices in Canada rise faster than expected, or if wage growth remains high relative to productivity.”
Asked whether there is a limit to how the Bank of Canada could lower interest rates independently of other major central banks without worrying too much about the impact it may have on the Canadian dollar, Macklem said, “In Canada we have our own currency; we have flexible exchange rates. What that means is that we can gear monetary policy to the needs of the Canadian economy.”
“We don’t need to move in lockstep with the Federal Reserve,” he said.
But the governor also noted that since the Canadian and the U.S. economies are closely linked and their financial systems are integrated, BoC officials take those into account when setting economic forecasts and monetary policy.
“There are limits to how far we can diverge from the United States but we are not close to those limits … and we will continue to get inflation back to target and run monetary policy in Canada within those,” he said, without elaborating further.
Some economists have said rate cuts by the BoC in the absence of Fed action could lead the Canadian dollar to depreciate against the U.S. currency and thus could provide unnecessary stimulus to the Canadian economy by making exports cheaper and it could also push up import costs.
The governor said Governing Council “discussed all these things” when asked whether there was any discussion as to how today’s rate cut could affect the value of the Canadian dollar and import costs, and how the policy difference with other major central banks could affect the real economy.
Senior Deputy Governor Carolyn Rogers added that while the decisions by central banks were “in concert” at the early stage of surging global inflation, “as inflation comes down, what is remaining for most of us is dealing more about our domestic economy. So, it is more logical that we are going to diverge a bit.”
Rogers also told reporters that the housing market continues to be “a risk to our inflation forecast” because of pent-up demand amid supply shortages but reminded, “We don’t target any particular measure in the housing market or interest rate.” Rogers said Canada has two different issues that are squeezing households: Not only high mortgage rates at housing loan renewals (due to high interest rates) but also high rents (which comes from high inflation).
Despite expected higher costs for home owners when their mortgages are being reset in coming few years (Canadians don’t have 30-year fixed mortgages as Americans do but their standard practice is a five-year mortgage amortized over 25 years), the Canadian economy has resumed growth in the first quarter and the BoC expects household spending to strengthen this year: “So far it looks like soft-landing,” Macklem said. “The plane hasn’t been landed yet, so we are not cheering yet, but the runway is in sight.” He noted excess supply in the economy should allow growth without sparking higher inflation.
Since the April meeting, consumer inflation first has eased from 2.8% in February and to a three-year low of 2.7% in April (since 2.2% in March 2021), making a steady progress from last summer’s peak of 4% and the recent high of 8.1% hit in June 2022.
Two of the BoC’s core inflation measures have also shown some improvement. The year-on-year increase in the CPI trim has eased to 2.9% in April after staying at 3.2% in March while the annual rate of the CPI median slowed further to 2.6% in April from 2.9% in March and 3.1% in February. Those measures strip out whatever is volatile at the time.
The latest GDP data showed the economy cooled off in March, being flat on the month, after making a robust start to the year with a 0.5% jump in January. In the first quarter, the real gross domestic product grew 0.4% on quarter, or an annualized 1.7%, below the consensus forecast of a 2.3% rise and the BoC’s April projection of 2.8%. The annualized growth rate in the previous quarter was revised down to a slight 0.1% from 1.0%.
The January-March quarter growth was led by higher household spending on services (telecommunications, rent and air transport) while a slower inventory buildup moderated overall growth, which indicates that the details are not so weak as the headline numbers suggest. Yet Canada’s economy has expanded by a meagre 0.5% in the past year.
Canada’s volatile employment data showed job creation jumped 90,400 in April after dipping 2,200 in March. The median forecast for Friday’s May report is a 15,000 increase. The unemployment rate was unchanged at 6.1% in April after rising to the level in March from 5.8% in February. An encouraging sign for BoC policymakers is that the year-on-year increase in average hourly wages eased to 4.7% in April from 5.1% in March, the second slowest reading of the past year.