The Bank of Canada’s monetary policy is working as intended to tackle inflation, says Governor Tiff Macklem, as the central bank prepares to pause its campaign of aggressive interest rate hikes.
Economic signs are showing that the hikes are discouraging Canadians from spending, thereby lowering demand and price pressures, after a year of inflation rising to four-decade highs, says the head of Canadian monetary policy.
While global factors such as easing of supply chain disruptions have played a role in lowering prices in recent months, he also points to the central bank raising its policy rate by 4.25 percentage points in the past year and the ensuing impact on inflation.
Headline inflation peaked at 8.1 per cent in June of 2022, with the most recent figure for December showing annual price hikes have cooled to 6.3 per cent.
“With inflation above six per cent, we are still a long way from the two per cent target,” Macklem said Tuesday. “But inflation is turning the corner. Monetary policy is working.”
Macklem made his comments, largely in French, during a speech to a business audience in Quebec City. An English transcript of his prepared remarks was posted online.
He reiterated the central bank’s forecast that economic growth will be essentially zero over the next three quarters — risking a possible recession in Canada, but effectively relieving “inflationary pressures.”
Higher interest rates have “moderated” household spending, he said, particularly in sectors such as housing that are sensitive to rate changes.
The Bank’s preferred measures of core inflation remain stuck around the five-percent mark annually, he said, but shorter-term three-month gauges suggest these figures will drop below that bar in the months ahead.
Macklem added there are also signs Canada’s tight labour market is starting to ease and expectations from Canadian businesses show they’re not including high inflation in their long-term pricing plans.
But while the prices of goods have dropped from earlier highs, a possible stickiness in services inflation is among the biggest risks to the Bank of Canada’s inflation outlook, which sees inflation dropping down to three per cent by mid-year.
Possible volatility in global energy prices — a significant factor fueling inflation in 2022 — is also a risk the Bank of Canada is watching closely, Macklem said.
Accordingly, while the central bank announced plans to pause its rate increases last month to let its hikes to-date work their way through the economy, Macklem reiterated Tuesday that the Bank is prepared to “act forcefully” and continue to raise rates if data shows inflation is not declining in line with its forecast.
What impact will the interest rate pause have on housing?
Canada’s housing market, which was running hot entering 2022, was among the first sectors to cool last year as higher interest rates hiked the cost of borrowing and made mortgages more expensive.
Macklem was asked after his speech Tuesday whether he thought the central bank’s stated pause on rate hikes could stimulate housing activity and inadvertently fuel inflation further.
He went back to the Bank’s latest forecasts in January that called for further slowing in the housing market this year — though it won’t be at the dramatic pace seen through much of 2022 as rate hikes took hold.
Macklem said the central bank expects home prices to continue dropping until around mid-year in Canada, but after that point, the market could pick up again. He cited the strong rate that Canadian families are forming and will look for housing, as well as increased immigration, as factors that will fuel demand.
Macklem acknowledged there’s some “uncertainty” in that forecast. Higher interest rates could have a “more powerful” impact on households than first thought and push the market to slow even more, he said.
But he also conceded that reaching the possible peak of interest rates for this cycle could convince some buyers and sellers to come off the sidelines and restimulate mortgage demand.
“The fact that we’ve paused may bring people back into the market. These are things we’re going to have to watch,” he said.