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On Wednesday, the Bank of Canada increased its benchmark rate a quarter percentage point, to 4.75 percent. That’s the highest it’s been since 2001. A combination of stubborn inflation and an economy that just keeps humming along explains why the Bank decided it needed to hike again after a pause of several months. Scotiabank’s Chief Economist Jean-François Perrault is back this week to walk us through the decision, the reasoning behind it, why it was the right thing to do, and to explain what it means for households – especially those with variable-rate mortgages - and the economy in the coming weeks and months.  

Key moments this episode:

0:54 — JF’s reaction to the decision
1:25 — Some insight into what factors drove the Bank of Canada’s decision 
3:38 — Breaking down the latest inflation numbers that contributed to the hike
4:54 — What is driving Canada’s unexpectedly robust economic growth?
7:16 — JF explains why even though this seems like the right decision economically, it will still bring some pain to Canadians
9:41 — What is the likelihood of another interest rate hike in July?
10:02 — When will we see some rate relief given this latest decision?
10:57 — Does all of this make a recession this year more or less likely?


Stephen Meurice: Interest rates are once again on the rise. On Wednesday, the Bank of Canada increased its benchmark rate a quarter percentage point, to 4.75%. That’s the highest it’s been since 2001. Scotiabank’s Chief Economist Jean-François Perrault is back this week to walk us through the decision, the reasoning behind it and explain what it means for households and the economy in the coming weeks and months. I’m Stephen Meurice and this is Perspectives.  

JF, thanks as always for joining us.

 Jean-François Perrault: Pleasure to be on.

 SM: So we'll jump into it. You and your colleagues at Scotiabank Economics were among, I think, a pretty small number of experts who thought the Bank of Canada should raise their benchmark rate. I don't know if you thought that they would do it, but in any case, they seem to have heeded your advice. What's your reaction to the announcement other than “I told you so?”

JFP: Well, first, it's nice to be right, so there's that immediate reaction. But, listen, the fact that they're raising rates, it's not a great thing, right? It's a reflection of the fact that inflation is perhaps going in the wrong direction, that it's stubbornly elevated, that we need to do a little bit more to bring inflation down. And that needing to do more obviously means higher interest rates. And in so doing, causes a little bit more harm to Canadian firms and households. So it's nice to be right, but it comes at the cost of, you know, some pain for people.

SM: Right. So can you talk to us a little bit more about the factors that drove the bank's decision today?

JFP: Yeah, I mean, it's a pretty broad range of considerations. Now obviously, we had inflation in April, underlying measures inflation, so core measures of inflation, so things that kind of suggest where inflation, momentum wise, accelerated pretty significantly in a month-over-month basis. So that is one data point, it's not the end of the world. But, you know, it was one that pointed to inflation going a little bit off script, if you will, given the fact that when the governor announced a pause several months ago, that pause was conditional on inflation continuing to go down in line with their view and growth slowing. So we got this bit information which suggests that inflation actually is not doing its part on that side, in addition to a broad range of information that suggests that economic activity is also more resilient. So we had a bunch of data on that. We had GDP for the first quarter, which was stronger than anybody had expected. We have indications so far for economic activity in the second quarter, so kind of a sneak peak at April, which suggests that April was stronger than expected. So possibly a second quarter might be stronger than we all expected as well. We obviously have the housing market, which is rebounding very, very strongly in many parts of the country, to a point where StatsCan actually noted that the acceleration is almost certainly due to the Bank of Canada's pause, so the Bank of Canada policy from a few months ago. And that's actually, as we think about it, that's a pretty important thing because the housing market had been weak, of course, for many, many quarters now because the Bank had been raising interest rates. That acted as a dampener on growth. We still grew fairly strongly in the first quarter and last year, but that's despite, if you will, a housing market adjustment. So, you know, really, we're in a position where we can ill-afford kind of a resumption of housing market strength when the Bank of Canada is trying to keep things from accelerating. Certainly they want it to slow down. And housing is the most interest-sensitive part of the economy. So if that part of the economy is no longer co-operating and no longer on script, it’s an element that suggests, again, that maybe the Bank of Canada needed to do a little bit more to cool things down.

SM: Right. I don't want to get too much into the weeds of the inflation question, but as I understand it, there are different things that they look at in the course of looking at what that overall inflation number is. And a couple of them are, I guess are okay or in fact, continue to go down, that were part of their calculation, things like core inflation I think has gone down a little bit, and service inflation I guess, inflation in the service sector of the economy, those good signs were not enough to make up for the negative aspects of the direction of inflation?

JFP: Yeah, yeah. I mean, what we've been focusing on the last several months now is not the year-over-year change in inflation, but the month-over-month change in inflation. Year-over-year inflation continues to decline. I mean, it picked up a little bit last month, but not a big deal. There's a general downward trend there, and that's because you have these base effects from last year. And as you kind of roll forward, these things drop off and inflation gets lower and lower on a year-ago comparison basis. But what really matters is kind of the momentum inflation and that you get by looking at monthly measures of inflation. So how did inflation April do relative to March? And how did March do relative to February? And there, that's where we were worried. We saw in April an acceleration in some pretty broad measures of inflation, underlying inflation, core inflation on a month-over-month basis, even though on a year-over-year basis, you're not really seeing a whole lot of that.

SM: Right. And on the other factor that you mentioned, which is the sort of unexpectedly robust economic growth, what's driving that? Where is that coming from?

 JFP: Well, it's coming from, again, some of these interest-sensitive parts of the economy. So, for instance, in the first quarter, we saw consumption being much stronger than we’d anticipated. Of course, consumption is what households do with their money. And if that isn't slowing, in fact, if it's accelerating, that does suggest, again, that the Bank of Canada’s attempts to slow the economy, which it does by raising interest rates, encouraging us to spend less on consumption, if that's not playing out and hadn't played out in the first quarter, again, it's great news in the sense that the economy is strong, but it's not great news if you're a central bank and you're trying to slow things down to achieve your inflation objective over a period of time.

SM: Right. So, yeah, we've been reading about, everybody's going out to eat in restaurants again and spending on their homes and so on, all that stuff. Is that a result of savings that people are still carrying over from during the pandemic?

JFP: Yeah. So there is there is some of that, some of that is still pent-up demand. People are still kind of, you know, doing things that they didn't do enough of during the pandemic. So there's a little bit of that left. Some of it is financed through savings because we know that deposits are still very high in a broad range of households. So they're using that to help pay for some expenditures. But we also know that there are indications that that is actually starting to slow now. So there are signs that consumers are starting to feel the impacts of higher rates in a pretty tangible way. Depends on, of course, what level of income you have, where you are in the country. But there is evidence of that. I think the big challenge for the Bank has been also in kind of this consumption space. You know, we have been experiencing a very, very significant increase in population. And of course, those people that come into the country, they buy goods, they buy services, they need housing, they need a range of things. And while that may not have much of an impact on the inflation dynamics, it certainly adds to growth in the short run. So, you might be trying to slow the economy with higher interest rates. But on the other hand, you have, a million more people last year into the country, it looks like that pace is accelerating so far this year. So these are people that are effectively kind of human stimulus. So they're keeping our economy stronger than it otherwise would be, again despite attempts by the Bank of Canada to slow things down.

SM: Okay. So in your view, the central bank's decision today was the necessary and proper one and will hopefully, speed up getting inflation under control. But there's no doubt, as you said from the outset, this is going to make things tougher for some people and maybe for some businesses. What's the downside here? You've been talking about real estate as well. Obviously, people will, at least with variable rate mortgages, this is going to continue the pain.

JFP: 100%. I mean, the governor will never say we want to make it hurt, but he wants to make it hurt. He's got to cause a little bit of pain. We have to see, you know, less strong job growth. We need to see weaker economic activity. They need to see some insolvencies pick up. There needs to be a sign, an indication that all these rate increases that they've engineered are working through the economy in a way that reduces economic activity. Now, the counter to the argument, you know, so we had his view that they should raise interest rates. You know, there are others that don't think that was necessary and still probably don't think that's necessary. And they would say something like, it's still maybe a little bit too early to fully assess the impact of all the rate increases we've done in the past. And maybe, as we go forward, we'll see those materialize in a very concrete way such that we actually didn't need to do the 25 basis points that we did this week. You know, time will tell. The reality, I think, is the Governor has very little optionality here because inflation is still too high. Because he made this promise to Canadians saying, you know, I'm going to pause interest rates if growth slows and inflation slows. And those are not slowing as much as he'd anticipated. So he's kind of got a credibility issue that he's got to manage. And I also think he's trying to signal to people, 25 basis points in of itself, isn’t a deal breaker. Obviously, it means that interest products are more expensive and people pay more in interest, which nobody likes. But, you know, it's you know, it's not a 50-basis point move, it's not a 100-basis point move, which they've done in the last year. And I think part of what they're trying to do is basically make people aware that there is a risk that interest rates keep going up or that interest rates don't fall over the course of the year, which is what some people currently believe. And so this idea that you're kind of creating uncertainty about where the interest rate path goes will force people to be a little bit more cautious about how they approach decisions because they may think that, well, six months from now, I might actually pay even more for stuff than I do now. So there is, I think, a bit of a shot across the bow dimension to this where they just say listen, ‘We're worried. We're raising rates now. We may or may not do some more, but you keep that in mind as you think about your savings and spending decision.’

SM: Right. And, you know, as you just said, they left the door open to another possible rate hike at their next announcement in July. At this point, what do you think is the likelihood of that?

JFP: They basically said we're data dependent. You know, it'll depend on, we have another inflation print before that. We have some job numbers, we have some numbers on Friday. I'd say right now it's 50-50, but it depends very, very, very much so on how the data comes in the  next six or seven weeks.

SM: And given today's announcement, potentially another increase in July, people, I guess, shouldn't be expecting any rate relief until what, well into 2024?

JFP: Absolutely. And the governor has been pushing back on that, in the U.S. Chairman Powell has been pushing back on that as well, because markets had been pricing in rate cuts in both countries for some time, much more so in the U.S. than in Canada, but both countries. And this is I mean, this is about as clear as you're going to get in terms of, you know, we're still raising interest rates. So it's actually foolish for you to think about us cutting rates in the next several months.

SM: But well into next year do you think? Like middle of next year?

JFP: Certainly early next year, early to mid next year. Again, it depends on how the economy adjusts to what we've seen and whether there's a much more pronounced reaction to the higher interest rates as we go forward in the year than we've seen. So that's certainly the first half of next year for us for sure, whether it's early next year, the kind of middle next year, it will be dependent on that.

SM: Okay. Last question. Does all this, all this stuff you've been talking about, does it make in your mind a recession more or less likely sometime this year?

JFP: Well, perversely, it's probably less likely because one of the drivers of this decision is an economy that is kind of refusing to slow down. This is an offset to stronger growth. And so far in the growth versus interest rate battle, growth has been winning out. So, you know, I'd say the likelihood of a recession, certainly one that begins in the second quarter, has dropped dramatically based on the data that we've seen. And that means you've got to think about, you know, the risk of a recession becoming even lower as we kind of internalize the strength and figure out where the economy's going to go.

SM: So at least it makes maybe the pain of the increasing interest rates a little bit more bearable if, generally speaking, the economy is still on track.

JFP: Well, this is exactly right. The fact that they're raising interest rates is because the economy is stronger than we thought. Had they not moved interest rates, had they cut interest rates, that would have been because the economy's actually in a worse spot than people would like.

SM: Okay. I think we will leave it there. JF, thanks as always for your time today. Really appreciate it.

JFP: Thanks very much, Steve.

SM: I've been speaking with Jean-François Perrault, the Chief Economist at Scotiabank. The Perspectives podcast is made by me — Stephen Meurice — Armina Ligaya and our producer Andrew Norton.