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As widely expected, the Bank of Canada today held its policy interest rate steady at 4.5%. It’s welcome relief for Canadians after a year of consecutive rate hikes. The central bank made good on its word back in January, when Governor Tiff Macklem said it was taking a “conditional pause” on interest rate hikes amid signs that inflation was slowing. Scotiabank’s Chief Economist Jean-François Perrault returns to the podcast to chat with Armina Ligaya from the Perspectives newsroom team and break down how long this pause may last, when we could see rates begin to drop and why the U.S. central bank’s anticipated hikes may have a ripple effect on the Bank of Canada.

Key moments this episode:
00:45  — What is behind the central bank’s decision to hold steady on rates today?
2:40 — Are Canadians done with rate hikes?
3:38 — What about murmurings of a rate hike before the end of the year?
5:41— The Fed is still hiking rates, does the Bank of Canada have to follow suit?
8:12 — Can inflation get down to 3% this year and 2% next year in Canada?
9:49 — What is the central bank trying to signal with their statement today?
11:46 — When can Canadians see interest rate cuts?


Stephen Meurice:  As expected, Canada’s central bank is standing pat. Bank of Canada Governor Tiff Macklem announced this morning that the benchmark interest rate will remain at 4.5%. The “conditional pause” that he promised in January, after eight consecutive rate increases, is still in effect. Scotiabank’s Chief Economist, Jean-François Perrault, is back again this episode. He’ll be talking with Armina Ligaya from our Perspectives Newsroom team to explain the bank’s latest decision, what it might signal and even give us a sense of when Canadians might see rates go back down. I’m Stephen Meurice and this is Perspectives.

Armina Ligaya: JF, thanks so much for joining us today. 

Jean-François Perrault: It’s a pleasure.

AL: So, when you were last on the show in January, the Bank of Canada signaled that it would take a conditional pause on interest rates. What was that conditional on and what economic developments have since led to the central bank's decision to hold today? Does this mean that the previous hikes are essentially doing what they're supposed to?

JFP: I think it means a couple of things. So, going back to when they originally were, I guess in January when they said they were going to hold off for a while. They made it very clear that that was conditioned on the economy evolving as they hoped or forecast it would. So that means inflation continued to come down, economic activity slowing gradually. And the evidence that we've received since that meeting are consistent with that. So, you know, inflation is slowing a little bit, economic activity is slowing. Although the labour market remains very, very tight, economic activity is slowing. So, there isn't really any reason for the governor to turn around and say, actually, you know what, since the last time we met, things have gone in the opposite direction of what we’d anticipated. So that's in terms of explaining why I think they felt comfortable with keeping rates at current levels today. Secondly, if we go back to January when they'd made that statement, you know, part of the thinking, there seems to have been, ‘listen, we know we've moved rates a lot. We know that there's a lag between when those rates change and when they ultimately impact spending behaviour. And we think we've done enough. So we're going to see if we have, in fact, done enough. So we've got to give ourselves a little bit of time because there are these long lags between when rates move and when, economic activity is ultimately impacted. We're going to give ourselves a bit of time to see if we're in the right ballpark or if we need to do a little bit more. Probably not, if they need to do less. So we're kind of in a holding pattern for a few months until we get more evidence that things are on the right track. So far, they seem to be, but, you know, six weeks of data isn't a whole lot of information to make a very long-term judgment on. But so far, so good.

AL: So after essentially a year of hikes, Canadians must be breathing a bit of a sigh of relief. Is that actually warranted? Are we done with hikes?

JFP: The hope is that we are done with hikes. And of course, when the central bank governor’s saying, ‘We think we're done with hikes subject to, you know, various things happening,’ like it's clearly an indication that we are, if not done very close to being done. So you know, folks that were worried about, for instance, prime going up a lot more. For instance, folks that were worried about mortgage rates going up a lot more. We are definitely in a world now where there is much less concern about that. There's obviously concern about dealing with the rate increases that we've already seen. And those are again, they're working their way through. And some people are going to renew their mortgages next month and the month after that at much higher rates than they did. But I think it's a reasonably good situation to be in, to be able to have a little bit more certainty about the rate path going forward than we had certainly before Christmas and certainly last summer.

AL: So on the other hand, as well, from what I've been reading, you know money markets, investors, overnight swaps, all that seems to point to some expectation of about a quarter percentage point hike before the end of the year. So on one hand, there's some relief. There's finally been a pause, but there is some expectation that a hike is coming. So what does that mean? Is that a realistic expectation that this hike will come or are we going to get a longer stretch of hike-free time?

JFP: Yeah, I think there are two things that are driving that. The first is, the governor's indicated that he hopes to be done, but the risks are clearly that he's not. Right. So if you think of it from a probabilistic perspective, between now in the next five or six months from now, it's much more likely that he would raise rates than he would cut them. And if he's going to move, it's going to be to raise rates. So, you know, markets price some of that in. So that's one thing. The other is  what's happening in the U.S. So obviously, the economy is heavily dependent on what happens in the U.S. and monetary policies in Canada is to some extent impacted by monetary policy in the U.S. And in the U.S. inflation isn't slowing as rapidly as is in Canada. The economy isn’t slowing like it is here. The Fed's got more rate increases to do. Does it have another 50 basis points to do, 100 basis points to do? Markets are trying to digest that now. So that means that U.S. interest rates are going to rise much higher than they would in Canada. And of course, that feeds expectations that maybe the Bank of Canada is going to have to do more itself. It's kind of  a normal historical situation that that if the Fed does a lot, we tend to be a bit of in the same boat in Canada. Now, the cyclical conditions are different. As I said, inflation is slowing here much more so than in the U.S. The economy is slowing here. There are tangible signs of that, not so much in the U.S. So we're in a different spot and we think that's sustainable. But because we know the rate tightening cycle isn't over in the U.S., the risks that that poses from a rate perspective in Canada is that rates would have to go up. So you've got markets pricing that in Canada, of course in the U.S. as well, as folks look to the Fed to do more.

AL: Mm hmm. Well, that brings me to my next question specifically about that, because even just yesterday, the Federal Reserve chair was warning that the U.S. would have to be even more aggressive than they previously thought. So, and my understanding is, I'm hoping you can help break this down a bit. There can't be too much divergence between the two. So, does the Bank of Canada have to follow suit and what would happen if the Bank of Canada strayed too far away? How would that impact things like the loonie?

JFP: So ultimately, what matters for central bank policy in Canada is what's going on with inflation. Now, what happens in the U.S., elsewhere in the world obviously influences that. So there's a couple of dimensions in which that's playing out. So one of the reasons, for instance, the Fed is going to be doing more is because, again, the U.S. economy is a little bit stronger than it is in Canada in terms of dynamics. U.S. inflation is a little bit higher than is in Canada. It's not coming down as much. Because we are their main trading partner. If the U.S. is stronger, I mean, that does suggest that the risks in Canada are that growth might actually be a little bit stronger, right? Or that if American inflation is higher, we import a lot of stuff from the Americans. It could mean that inflation in Canada is at some point a little bit more stubborn, a little bit harder to bring down. So that channel is, of course, an important one for the governor to think about in terms of, how he needs to respond to. Like is there more inflation pressure? Is there stronger growth? The other is the exchange rate dimension, as you indicated. So one way in which inflation comes into the country is obviously we import stuff, but the exchange rate matters in terms of how expensive those goods are. So when the Canadian dollar weakens, it adds to inflationary pressure. And of course, one of the things that drives exchange rates are interest rate differentials. So when rates in Canada are much lower than they are in the U.S., that tends to put downward pressure on the Canadian dollar and therefore upward pressure on inflation. So there's a question of, fine, say the U.S. moves another 50 basis points, a hundred basis points and we're done. That is likely to put at the margin some downward pressure on the Canadian dollar and therefore at the margin, upward pressure on Canadian inflation. So that's, again, part of the things that the governor would have to keep in mind as he progresses. But ultimately, it's a function of inflation. If the governor thinks inflation is on track to do what he said it was going to do. If he's confident that inflation may be 2% next year, irrespective of what's going on with the dollar, or other things. That'll give him greater latitude to be able to not necessarily follow what's going on in the U.S. because his own objectives is more in reach, we’ll say, than the Americans at this point in time.

AL: So that brings me to my other question about where we are at in terms of getting inflation to a more sustainable, a more acceptable level. The Bank of Canada said today it wants to get to 3% inflation by sometime this year. From what we see, are we on track for that? And then, are we also on track for 2% sometime next year, like we were hoping for?

JFP: I think so. I mean, there's nothing in the data that suggests that that's that we're not on track for that yet. Now that being said, inflation is still very high, right? It's just under 6%. We are very far away from 2%. There's no question about that. And again, the bank had acknowledged that in their in their statement today. So it's by no means kind of mission accomplished. But, you know, inflation is coming down, pretty automatically in some sense, because a lot of the things that have pushed it up over the last year, year and a half are starting to unwind. So things like oil prices and energy prices more broadly, input costs and a normalization of supply chains. Those are things that are some extent not a function of monetary policy in Canada, and they are working their way through inflation. So for inflation to come down to 3%, that is totally realistic. We actually think inflation might be a little bit stronger than 3% this year. But whatever, we are in this camp of inflation declining. The question really is, you know, going beyond working through these things that we know have pushed it up and they're pushing it down. Is there enough there or is it going to become more challenging to get inflation from, say, 3%, 3.5% to where the bank had ultimately wants it at 2%? And that's where, you know, this pause is kind of helpful because it's going to help us assess do we really need to do more to kind of break through the 3% and get to 2% at some point, or has enough been done?

AL: Ok, I want to get to the big question here that most people are probably wondering about. Which is, when we may see interest rate cuts. But first I want to ask if there's anything that you heard or gleaned today from the Bank of Canada's statement that was surprising or caught your attention? What are they trying to signal with their statement today?

JFP: I think it was a is a pretty anodyne statement in some sense because it was pretty clear going into this meeting that they were not going to do anything. Because they said at the last meeting, we're going to wait a few months before we figure out what we need to do. The bar was extremely high to them moving today. That being said, I think the statement did a pretty good job of indicating on the one hand that economic activity outside of our borders is actually more resilient than we anticipated, which is a good thing, if you think of it from a growth perspective. Canadian inflation is coming down in line with expectations, which again, is a good thing. Still high, but it's a good thing. But, you know, they were very clear about indicating that, you know, inflation remains much, much, much too high. That they don't know, they can't be certain that inflation, in fact, will not require additional rate increases on our part. So I thought he threaded the needle pretty well from that perspective. He didn't give any insights as to when they might cut, and they would never do that. But I will say that given what Chairman Powell indicated this week, which is the U.S. is likely contemplating more rate increases than they thought and possibly a faster pace, so maybe, you know, a 50-basis point move at the next meeting. What that does is it may not trigger a response from the Bank of Canada in the sense that we may not want to follow them up, but we might want to follow them down. That is to say that it might mean that instead of having a rate cut later this year in Canada, that that rate cut is delayed to sometime next year as we just kind of let the U.S. economy and the U.S. rate policy kind of evolve to address their inflation situation. So that would be one way of mitigating, the exchange rate impact from a policy divergence in the U.S. as we just keep our rates at current levels for a little bit longer than we otherwise would. And that helps remove some of that pressure on the exchange rate at some point.

AL: Mm hmm. You answered a little bit of the big question in terms of what Canadians, particularly borrowers, are hoping for: when will we see interest rate cuts? So from where we stand now, when do you think that would happen? When could we see some interest rate cuts?

JFP: So we're thinking late this year, early next year. Probably more early next year, given what Powell has indicated this week. But, you know, I would suspect that this time next year, we are looking at lower interest rates in Canada. At least, I hope, because that means that means a range of things. Obviously matters for households and matters for businesses because the cost of financing start to go down. But it would also mean that that's in a world where inflation is pretty close to 2%, that we are very confident that we have kind of hit the sweet spot on inflation and that we've managed the uncertainty the next few months in a reasonably good way. So, if we do end up in a world where we're cutting rates again later this year or probably more likely in early next year, it will mean that we are in a far more predictable world. A world in which decision making is substantially easier than it is now and certainly than it's been over the last several quarters.

AL: Alright. Thanks so much, JF. I think we'll leave it there.

JF: Thank you.

AL: I've been speaking with Jean-François Perrault, the chief economist at Scotiabank. The Perspectives podcast is made by me, Armina Ligaya, Stephen Meurice and our producer Andrew Norton. Who hopes your rate of interest also stayed steady throughout this interview.