Multiple inflationary pressures complicate Bank of Canada’s soft landing target

A sign is pictured outside the Bank of Canada building in Ottawa, Ontario, Canada May 23, 2017. REUTERS/Chris Wattie/File Photo

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TORONTO, April 20 (Reuters) – As the Bank of Canada opens the door to raising interest rates above a neutral level for the first time in 14 years, the goal of controlling inflation without Trigger recession is challenged by multiple price pressures and record household debt.

To tackle a three-decade high for Canadian inflation, the central bank announces that it will raise its benchmark interest rate towards the neutral rate, which it estimates to be between 2% and 3%, adding that it may need to raise rates above this range .

At neutral, interest rates neither stimulate nor depress economic activity, so a move above neutral could increase the risk of a hard landing or a sharp downturn in the economy – a result that central banks hope to avoid.

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The BoC has not gone above neutral since 2008 or before. It released an update to its neutral estimate every year since 2017, raising it last Wednesday by a quarter of a percentage point.

“It may be a little harder to moor the boat, so to speak, than it has been for the last ten years,” said Greg Anderson, global head of currency strategy at BMO. Capital Markets.

“There are a lot of forces contributing to inflation and some of them may not be so temporary.”

An aging workforce, the transition to a greener economy and measures to reduce economic interdependence between countries are among the long-term drivers of inflation, while temporary pressures include shocks from supplies related to the COVID-19 pandemic and the war in Ukraine. The inflation rate in Canada was 5.7% in February.

The US Federal Reserve has also signaled that it may raise interest rates above neutral in the current tightening cycle. But the Canadian economy will likely be particularly sensitive to higher rates after Canadians increased their borrowing during the pandemic to participate in a booming housing market. Read more

Household debt represents 186% of disposable income, a level that is by far the highest among G7 countries, according to data from the Organization for Economic Co-operation and Development.

There is a big risk that markets for assets such as the housing sector “eventually crash as rates rise,” said David Rosenberg, chief economist and strategist at Rosenberg Research.

Last week, the BoC raised its benchmark rate by half a percentage point to 1%, its biggest hike in more than two decades, and said the economy was strong enough to withstand further tightening. Read more

Money markets are betting that the key rate will rise to 3% next year, which would be the highest since 2008 and well above the 1.75% peak of the previous rate hike cycle in 2017-2018.

Nevertheless, the narrow spread between Canadian 2-year and 10-year yields, at 35 basis points, indicates that investors expect slower economic growth. The flat yield curve comes as monetary policymakers become more hawkish overall after potentially waiting too long to cut support in the pandemic era. Read more

“The end result is (that) central banks … overestimated the amount of stimulus that was needed last year,” said Darcy Briggs, portfolio manager at Franklin Templeton Canada. “They have overstayed their welcome.”

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Reporting by Fergal Smith; Editing by Denny Thomas and Aurora Ellis

Our standards: The Thomson Reuters Trust Principles.

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