–Gravelle: BOC Not on Pre-Set Path Toward Specific ‘Terminal’ Rate
–Gravelle: Canadian Economy Can Take Higher Interest Rates
–Gravelle: Supply Chain Bottlenecks Could Last Longer, Spending Could Surge
–Gravelle: Canadians Have More Liquid Assets, Reduced Non-Mortgage Debts
–Gravelle: Prices Could Dip, Spending on Goods Could Slump in Shift to Services
–Gravelle: Households Highly Indebted in Housing Market May Cut Spending
By Max Sato
(MaceNews) – The Bank of Canada may need to keep raising its policy interest rate above the level deemed as neutral to economic activity or pause once it has reached the neutral range of 2% to 3% if commodities prices decline and households highly indebted in the housing market cut spending, BOC Deputy Governor Toni Gravelle said Thursday.
In a speech on how commodity prices affect the economy, Gravelle repeated the official line that the central bank is not on auto pilot in achieving a target for the short-term interest rates. The Canadian economy is in much better shape than in the past and thus can withstand higher interest rates, he said.
Gravelle estimates that inflation at 5% for a year, or 3 percentage points above the bank’s 2% target, costs the average Canadian an additional C$2,000 a year, which is affecting more vulnerable members of society the most because prices of essential items like food and gasoline have risen sharply.
“This broadening of price pressures is a big concern,” he said. “But this is not the 1970s all over again. Growth is strong in Canada, and the labour market is very tight.”
“Simply put, with demand running ahead of the economy’s capacity, we need higher interest rates to cool domestic inflation,” Gravelle said. “And as we’ve said before, the economy can handle it.”
Gravelle also repeated recent remarks by his colleagues that the bank is “not on a pre-set path” of policy rate increases aimed at getting to a specific “terminal” rate. “Our decisions are not on autopilot,” he said.
Looking at different scenarios going forward, he said global supply chain constraints could become more persistent and consumers could boost spending more than expected as Covid restrictions ease, which will cause the bank to raise the policy rate “modestly above neutral levels.”
“We may also need to raise rates above neutral because parts of the economy may be less sensitive to rate hikes than in the past,” he added.
Canadians are in better shape financially than they were before the pandemic as the average household has accumulated C$12,000 in liquid assets, and Canadians have reduced non-mortgage debt balances, he explained.
In addition, housing activity might be supported by factors that are not directly related to interest rate movements, such as stronger demographic demand from immigration, he said. Demand for bigger housing and in suburban locations that has emerged during the pandemic could persist much more than forecast, he added.
On the other hand, some factors might lead the bank to pause its policy rate increases as the rate enters its estimated range for neutral of 2% to 3%.
“One reason would be if price increases reversed course,” Gravelle said. “Commodity prices could start to decline, especially if the war in Ukraine is resolved.”
The process of normalizing the monetary policy can also be affected by “the bullwhip effect,” he said.
Consumer spending shifted toward goods from services during the early stage of the pandemic but now that the economy is reopening, spending on goods could decline faster than expected just as goods supply and inventories finally expand. “Faced with excess supply, retailers and manufacturers could put large discounts on goods. This too could reverse observed price increases,” Gravelle said.
“Another factor that might lead us to pause is that many households have taken on more debt to get into the housing market,” he said.
At the end of 2021, the household debt-to-income ratio was 186%, above the pre-pandemic level of 181%. And rising interest rates are designed to slow the economy by making borrowing more expensive, which will push up debt-servicing costs and will likely reduce household spending.
“Our base-case scenario includes a slowdown in housing activity. But we could see a larger-than-expected slowdown due to higher indebtedness and unsustainably high housing prices,” Gravelle noted.