How concerns over the housing market factored into the Bank of Canada’s latest rate decision
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Hike or take a break?
The Governing Council considered two options: leave the key interest rate at 4.25 percent or raise it by a modest 25 basis points to 4.5 percent. The argument for the pause was that inflation had moved in the right direction, falling to 6.3 percent in December from a peak of 8.1 percent in June.
The report added that there are two arguments for raising interest rates: first, that the economy still has excess demand and that the labor market is still stronger than usual. Second, to avoid stalling the declining pace of inflation anywhere above 2 percent, which would leave the bank struggling to get it back on target within the timeframe set by the central bank. The Governing Council pointed to ongoing supply chain challenges, service price inflation and wage growth as risks that could keep inflation above target.
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“Although the document revealed officials were debating whether to maintain a bias to hike or signal a pause, the decision to use the latter reinforces the moderate bias,” Mendes said in a note to clients after the report’s release. “Interestingly, there seemed to be no discussion of dropping forward guidance altogether, an option that was anticipated by many market participants.”
The Way of Inflation
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How quickly inflation can be brought back to target was a key concern of the Governing Council. Most agreed that inflation was turning, but that the picture was mixed, with lower gas prices leading the charge but services, food and shelter harder to tame. Members took a fall in durable goods inflation as a sign that higher interest rates were working their way through the economy and demand was slowing.
Overall, the Governing Council has pushed up the timeline for inflation to come down. The revised outlook now projects headline price pressures to fall to 3% by mid-2023, a lower level than indicated in the October policy report. While members were confident that inflation would fall further in 2024 and reach the 2% target, much depends on whether service sector inflation slows and labor cost growth slows. Another risk they discussed was that a rebound in oil prices could push inflation back up.
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Given these risks, Benjamin Reitzes, managing director at BMO Capital Markets, pointed out that the risks in the environment could lead to further rate hikes earlier in the year.
“Policy risk remains skewed towards further rate hikes in the first half of the year, at which point risks are likely to start reversing, provided inflation behaves well,” he wrote in a Feb. 9 reaction note.
The surprising strength of the labor market
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The council debated the extent to which job shortages would ease after consumer demand surged following economic reopening. While high immigration is expected to increase labor supply over time, members feared the rebalancing would not be immediate and shortages could persist.
impact on housing
The Governing Council was concerned that the impact of the central bank’s aggressive rate-hike cycle on the housing market could have been much larger. Canada’s hottest housing markets have seen double-digit price declines as more homebuyers are sidelined due to higher mortgage carrying costs. There is still a risk that house price declines could accelerate, but the Governing Council noted that additional demand for housing from immigration could put a floor on how low the average house price could fall across the country.
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Household debt could also be a source of slowing consumer demand as the central bank works to slow the economy. The Governing Council noted that many households with five-year mortgages would be rolling over in about a year, meaning they will face higher borrowing costs. As a result, a larger portion of Canadians’ net wages are used to service mortgages, rather than being spent in areas that boost the economy, such as B. restaurants, haircuts, etc.
“In many cases, they would face significantly higher monthly mortgage payments, and this could reduce other expenses more than expected,” the summary reads.
transparency report card
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Recommended by the editors
The publication disappointed in this regard, as it did not distinguish between the five Governing Council members present or assign names to specific opinions. Jay Zhao-Murray, FX analyst at Monex Canada, pointed out the shortcoming in his Feb. 8 reaction note but commended the central bank for bringing new information to the table.
“While the minutes of the meeting failed to allocate opinions to individual members, as Sweden’s Riksbank does, or to split voting on policy options, as the Bank of England does, the minutes offer considerable new information,” Zhao-Murray said. “All in all we give this protocol a score of 7/10 for transparency as it is really insightful but fails to provide some information that some G10 central banks offer.”