Central bank gambles Canadians won't get into the inflation habit: Don Pittis

More interest rate hikes are coming, but Stephen Poloz holds off to see how Canadians adjust to recent changes.

Real estate strength has just been delayed, say Bank of Canada governors

Bank of Canada senior deputy governor Carolyn Wilkins and governor Stephen Poloz gave Canadian borrowers a break this time, but will expectations of inflation take root? (Justin Tang/Canadian Press)

Canadian borrowers fearful of another hike in Bank of Canada interest rates are likely off the hook for three months at least.

There is a tiny chance central bank governor Stephen Poloz and his deputy Carolyn Wilkins could raise rates at the next meeting on May 30, but since there is no news conference scheduled to explain their actions, it's likely the next opportunity to hike won't be until July.

But the governors made it very clear at yesterday's meet-the-media session that Canadians must be prepared for a series of future interest rate increases.

"Our uncertainty is about how much and at what pace," said Poloz.

Housing slowdown

Poloz said the bank was surprised by how much the economy slowed down in the first three months of this year after a booming 2017, but according to a Bank of Canada analysis that will be temporary.
The bank's research shows housing activity "contracted sharply in the first quarter," according to the Monetary Policy Report. But Poloz attributes most of that decline to people responding to new, stricter mortgage rules that kicked in Jan. 1 by rushing their plans to buy.
A hopeful sign stands at an empty site in East Gwillimbury, Ont. The Bank of Canada says sales will pick up again soon. (Mark Blinch/Reuters)

Effectively, the real estate business that would have happened at the beginning of this year moved to the last few months of 2017 to beat the new stress tests, making the contrast between the two periods even more dramatic.

Poloz says that, and a temporary bottleneck in rail traffic that cut into exports, will begin to disappear from the economic data any time now, causing a sharp return to economic growth.

Bargain rates yield results

Overall yesterday's report contained good news. For years, bargain-basement interest rates have failed to spark inflation into life, but now there are clear signs the economy is kicking into gear.

Statistics Canada said in March that the annual inflation rate rose to 2.2 per cent in February, from 1.7 the month before.

In some ways Poloz and Wilkins are gambling that after years of low price rises and wages that have grown even more slowly, Canadians won't get too far into the inflation habit before the bank can cool things down.
The pause in rate increases comes while the central bank waits for more data on the future of the economy and inflation. While the bank is confident growth will continue, there are several reasons the pace of that growth remains uncertain.
The NAFTA talks are headed by Mexican Economy Minister Ildefonso Guajardo, Canada's Foreign Minister Chrystia Freeland and U.S. Trade Representative Robert Lighthizer. Uncertainty over the deal has slowed the growth of Canadian economic capacity, Poloz says. (Edgard Garrido/Reuters)

While talk of completing a NAFTA renegotiation with the U.S. and Mexico has become more optimistic in the last month, the bank says there are still signs economic capacity — the ability of Canada to produce goods and services — isn't increasing as fast as Poloz had hoped. 

Trade uncertainty and confusion over whether U.S. tax cuts would make it better to invest south of the border may have slowed Canadian business investment, not in real terms but compared to what would have happened without those uncertainties.

Rate reaction nightmare?

Bank of Canada researchers also want a better reading on consumer reaction to rising interest rates. Wilkins has said high Canadian household debt levels as interest rates rise keep her awake at night.

The bank says Canadians are beginning to rein in their debt. The difficult question for Wilkins and Poloz is how strongly Canadians will respond to recent rate rises, and perhaps even more unpredictable, how they will respond to the prospect of more increases to come.

According to yesterday's report, the neutral rate, the interest rate that would neither stimulate nor slow the economy, is between 2.5 and 3.5 per cent, well above the bank's current 1.5 per cent level.
Striking CP Rail workers picket in Coquitlam, B.C., in 2012. Rail workers have again threatened to walk out, and this time they will likely be looking for wage increases to help them catch up with inflation. (Andy Clark/Reuters)

The other thing that the bank wants to research before it makes another move is the Canadian reaction to inflation itself.

After years when prices hardly moved there is a growing perception that prices are rising faster than many people's wages.

Yesterday, Canadian Pacific Railway workers announced their intention to strike within 72 hours. The workers involved had turned down an opportunity to extend their existing contract for another year with a pay increase of two per cent — a rate less than current inflation.

Workers who received annual increments of between one and 1.5 per cent in the past few years are beginning to realize their spending power is dwindling as the prices of their purchases go up by more than two per cent.

Playing catch-up 

In B.C., for example, current annual wage increases for the public service negotiated by the previous Liberal government add up to increments of less than an annual one per cent. As those agreements expire, employees will be asking to make up for those losses.

"We have noted before that we would expect wages to be growing by around three per cent in an economy operating close to capacity," said Poloz.

He sounded quite proud that the analysis by his team correctly predicted inflation would hit the midpoint of the bank's two per cent target about now.

That same team of analysts says inflation will go higher yet, significantly above two per cent in the coming year, but then fall back to two per cent in 2019. They say the economy will still need help from below-trend interest rates.

But for now, as they refrain from using rates to keep a lid on inflation, Poloz and Wilkins will be hoping Canadian businesses planning to raise prices and wage earners hoping to catch up on more than a decade of losses have read the bank's predictions and will keep singing from the Bank of Canada's moderate-inflation song book.

Follow Don on Twitter @don_pittis

About the Author

Don Pittis

Business columnist

Don Pittis was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.


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