The Bank of Canada has adopted a more flexible approach to its messaging strategy compared to January when it announced a pause in rate hikes that resulted in a resurgence of the housing market. This led to increased inflation and the need to resume tightening measures five months later. After raising rates to a 22-year high of 5.0%, Governor Tiff Macklem took on a more aggressive tone and warned that the bank could increase rates again if economic data indicated the need. This change allows the BoC to be less susceptible to criticism when forecasts are incorrect and allows investors and borrowers to form their own opinions on the future of interest rates.
Derek Holt, Vice President of Capital Markets Economics at Scotiabank, commented on the ineffectiveness of forward guidance provided by the governing council, stating that it does not yield positive results. Central bankers globally have struggled with underestimating inflation and difficulties in communicating their intentions. Macklem faced criticism from opposition politicians last year for misjudging inflation and adhering to inflexible forward guidance.
When the BoC announced the pause in January, Macklem stated, “We are turning the corner on inflation.” He further stated that if economic developments and inflation aligned with predictions, it would confirm that the bank had done enough. However, the markets quickly factored in anticipated rate cuts by the end of the year, and the housing market rebounded. The Canadian Real Estate Association reported a 19% increase in the average sale price of homes between January and May. The BoC predicts that this surge in housing prices will likely persist, leading to an inflation boost of up to 0.3 percentage points by the end of 2023, compared to the January outlook. Macklem defended the decision to pause, explaining that it allowed the bank to assess the impact of the rapid rate increases. However, the economy surpassed the bank’s expectations, a recurring trend in recent years.
The tightening campaign by the central bank raises concerns for Canadians who have accumulated debt in the form of cheap mortgages, credit cards, and other loans. Household debt as a percentage of disposable income rose to 184.5% in the first quarter, nearing a record high. This translates to $1.85 in debt for every dollar of disposable income.
During the announcement of last week’s 25-basis-point rate hike, Macklem did not use the word “pause.” Some analysts now predict that the bank might revert to a pause in rate hikes. Derek Holt suggests that the central bank has matured and is unlikely to repeat the same strategy again. Despite economists’ doubts about another rate hike, money markets are not shifting their bets towards a possible rate cut, mainly due to uncertainty in the inflation outlook and the bank’s warning of further increases if necessary.
Macklem has previously delivered misleading messages. During the pandemic, he assured Canadians that rates would only rise in 2023 when economic slack was expected to be absorbed. However, the central bank began hiking rates in March 2022 as inflation surged. In October 2021, he forecasted that inflation would return to the central bank’s 2% target by the end of 2022 but revised this projection to end 2024 in January of this year. Last week, the bank further delayed the target to mid-2025. Market strategist Marc Chandler suggests that the two rate hikes starting in June after the pause announcement indicate that the central bank acknowledged their previous mistake and is now making up for it.
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