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In his report last week, Scotiabank’s Chief Economist Jean-François Perrault forecast the Bank of Canada would hike its key interest rate this week in a bid to dampen inflation. But the Bank has decided to leave the interest rate at a historic low for the time being. Perrault joined the Perspectives podcast for a special bonus follow-up episode to help explain Bank of Canada Governor Tiff Macklem’s unexpected announcement.

“So he explained it in a couple of different ways. One is he pointed to Omicron creating some uncertainty with respect to the outlook and inflation, which is defendable. But he also then pointed to their desire to want to be deliberate in the process of raising interest rates,” Perrault said during the podcast.

While that means they didn’t raise rates this week, Perrault stands by his forecast that the Bank of Canada interest rate will still rise to 2% by the end of the year. “The governor was pretty clear that they are going to be undertaking a path to higher interest rates, so effectively an interest rate campaign. Meaning that rates are going to go up significantly."

English Transcript:

Stephen Meurice: I’m Stephen Meurice and this is Perspectives.  

Last week on a special bonus episode we talked to Jean-François Perrault. He’s Scotiabank’s chief economist. And he told us why he thought the Bank of Canada would start a series of interest rate increases beginning this week.  

(CLIP FROM LAST WEEK) Jean-François Perrault: We’re in the early phases of what we expect to be a pretty serious phase of monetary tightening in Canada. 

The idea was that an interest rate hike would help slow inflation. Inflation that has risen to levels not seen in decades. Well, the Bank of Canada surprised quite a few people — including, apparently, JF. The Bank stood pat. They left their overnight interest rate at its historic low. At least for the time being. So, we’ve invited JF back on today. This time to help explain the Bank’s decision. And to tell us what it means for the economy and for Canadians. 

Let’s get started. JF, thanks for being here on short notice again. 

JFP: You’re very welcome. 

SM: I want to start with some of the reporting on your reaction to this decision, yesterday. I saw you quoted as saying that the Bank of Canada is a little less credible now than it was yesterday as a result of this decision. Maybe you can start by telling us what the decision was and how Tiff Macklem, the Governor of the Bank of Canada, explained that decision. 

JFP: Well, you know so yesterday the bank of Canada published a new set of forecasts along with its decision. And those forecasts pointed to a very significant increase in their forecasted inflation for 2022 and a little bit in 2023. In addition to him kind of characterizing the economy is basically being at full employment, which is earlier than they had anticipated, indicating that he thought the economy was characterized as being at equilibrium in the sense that the output gap is closed. So these are all things that he pointed to in the past as saying once this happens, we’re going to raise interest rates. So they happened and he said ‘Not quite ready to raise interest rates now, but they’re gonna rise at some point in the future,’ So that’s a little bit of tension that we were talking about yesterday. 

SM: So what was the rationale for postponing a decision on increasing rates? He did say that you know, the inflation is a serious issue, that they will be raising rates, probably in their next rate announcement. But how did he explain the decision not to do it now? 

JFP: So he explained it in a couple of different ways. One is he pointed to Omicron as creating some uncertainty with respect to the outlook and inflation, which is defendable. But he also then pointed to their desire to want to be deliberate in the process of raising interest rates. So one thing that he did do yesterday was indicate that the forward guidance that they had provided, which was basically to say ‘we’re going to raise interest rates when the output gap is closed’ that those conditions have been met, and therefore that they were no longer operating under that guidance. And in his mind, certainly as he talked about it, it was very clear that he thought that was a significant monetary policy move, which laid the groundwork for an eventual interest rate increase, whether that’s in March or later on in this year. So you know, a couple of different ways, and none of those are entirely satisfying to us, but that’s generally how he explained it. 

SM: So maybe to go back to that, quote of yours that you made to a reporter yesterday, why is the Bank of Canada a little bit less credible now than it was the day before? 

JFP: So there’s a few reasons for that. One is, you know, our sense was that in removing the guidance and saying that the output gap was closed, he was giving himself the green light to move ‘cause he’d indicated  it in the past, that he wasn’t going to move until the output gap is closed. So that’s one thing. And that output gap closed earlier than he said it was going to. So, you know, positive surprise on their forecast. The other dimension of it is, you know, the markets had basically been giving him a pass on this one. It was largely priced in, not entirely priced in, but largely priced in, which meant that it wouldn’t have come as a surprise that he done that. What it did do it, though, is it came as a surprise that he didn’t. So as a result of the decision, you actually saw more stimulative financial conditions come out of that. So you had a decline in in in bond yields. You had a depreciation in the Canadian dollar. Which is inconsistent with his stated objective, which was to indicate that effectively monetary conditions are going to be tighter, the country needs more restrictive financial conditions. Yet he delivered yesterday a policy statement and a policy action that led to in the short run at least, the opposite of that. 

SM: Right, okay so let’s talk about some of the impacts of the decision. You described a couple of them already. On the economy, broadly speaking, what’s the impact of this delay? And I guess more specifically on the battle against inflation. People talking about bare shelves because of supply chain issues and rising prices, and all those things. What, if anything, is the impact of the delay in the decision now? 

JFP: The hard reality is that whether they move by 25 basis points now versus March, it’s not a huge difference. There’s a signaling effect which is more important in our mind, you know, so we’re questioning whether or not they put as much priority on inflation stabilization as we think they need to. Because the background on the inflation side is, true there’s been some supply impacts. True, that the food prices have risen very rapidly on account of a range of different things. It’s true that oil prices have gone up, and that’s contributed inflation. These are all things the Governor pointed to, but signaling that a lot of these things are temporary, and in fact that by the second half of this year, inflation dynamics are going to be very different, which is again also what he’s done. Just you know, it left a little bit of a taste in our mouth that maybe you know they’re not as concerned about inflation as, say, corporate Canada is, as households are, as we are. And that’s the tricky part, you know, even though they haven’t moved, they’ve indicated they’re going to. It leaves a little bit of a taste in our mouth that maybe they’re not as fussed about inflation as we think they need to be. 

SM: Right, so it’s a question of building up or establishing expectations in the market, among the consumers and so on.  

JFP: Exactly. 

SM: Speaking of consumers, I saw some speculation about how deciding not to raise rates now is going to fan the already hot housing markets. That now we’re heading into sort of the spring buying season. And that this maybe will get more people to try and jump in before the rates start going up and contribute to a very frothy housing market. Would you agree with that? 

JFP: Well, certainly that’s the case. We are about to enter the spring real estate market. Perhaps we’re already in it. By signaling that interest rates effectively are going to be rising, presumably at the next meeting, or maybe a little bit afterwards, you’re effectively telling people that are thinking about going into the market that they should rush. You know, if you’re trying to minimize your interest costs, well, you’re better off getting a mortgage now or locking that in now and trying to secure a house now than you will be in a few weeks or a few months. So there’s unquestionably going to be an impact of a move later on in interest rates relative to now on housing market dynamics, that’s undeniable. We’ve seen that happen plenty of times in the past and that’s going to happen again. Now clearly, that’s not something they’re uncomfortable with. We thought that would have been something they kept in the back of their mind as they as move forward with their decision. But again, it’s an indication that they’re a little bit less fussed about some of these things then we are. 

SM: And final question — are you still comfortable with your forecast of the bank still getting to a rate of around 2% by the end of the year, which is what you were forecasting last week. Does the Bank’s decision this week change that at all? 

JFP: It doesn’t really change that. The Governor was pretty clear that they are going to be undertaking a path to higher interest rates, so effectively an interest rate campaign. Meaning that rates are going to go up significantly. Now is that going to be 175 basis points? Is that going to be 100? We’ll see. But I thought he was pretty clear in saying, ‘listen, we’re not moving today. But mark my words, we’re gonna move as much as we need to bring inflation under control.’ And that was amplified, oddly enough, yesterday by the Chairman of the Federal Reserve, Jerome Powell in the US, who also had an interest rate decision. He was much more circumspect about the amount of interest rate increases that they need. So the market had been pricing in for, in the US for rate increases. And he made it pretty clear that he didn’t think that was out of line. And in fact, that maybe more than that would be appropriate. He didn’t quite say it that way, but that’s effectively how he’s interpreted it. So even in the US you have the Chairman of the Federal Reserve indicating that they’re probably going to do more than people think, and you know, you can kind of back that right into Canada, and say if it works with the US, it’s probably going to be the case here since we have in some sense, a more tightly wound economy than the Americans do. 

SM: Well thanks for that JF, that was a great recap of this week’s events. Thank you for coming in on short notice. Always appreciate it. 

JFP: You’re very welcome, Steve. 

SM: I’ve been speaking with Jean-François Perrault, Scotiabank’s Chief Economist