Will inflation force the Bank of Canada’s hand on interest rates?

CIBC World Markets deputy chief economist on the BoC’s likely response to surging inflation

Will inflation force the Bank of Canada’s hand on interest rates?

The growing threat of inflation looms over the Bank of Canada as it prepares its second-to-last interest rate announcement of 2021, with Statistics Canada reporting this week that the national inflation rate is now at its highest in 18 years.

Sitting at 4.4% in September, that rate exceeded the Bank’s target range for the sixth month in a row, leading to speculation that the Bank could be jolted into movement on rates sooner than anticipated.

Canadian Imperial Bank of Commerce (CIBC) World Markets deputy chief economist Benjamin Tal (pictured) believes that those year-over-year numbers are something of a “mirage,” and the consequence of comparing elevated current prices with very low prices around the same time last year.

Still, he told Canadian Mortgage Professional that the Bank was likely to factor inflation concerns into its next statement (scheduled for October 27), with a more hawkish approach potentially in the offing.

“I think they will give a hint that the first move [on interest rates] will be in the second half of 2022 – but early in the second half of 2022,” he said. “I think they clearly will suggest that, although they still believe that [inflation] is temporary, and I think that they’re right.

“Temporary does not mean that it will end tomorrow. It can last for a few more months, well into next year, and I think that’s something that caught them a bit by surprise.”

Read next: What does CIBC's Benjamin Tal want to happen with interest rates?

Tal said the consistency of those price increases would be of particular concern for the Bank and a prominent factor in influencing its decision on whether to move swiftly on interest rates.

“Their nightmare is a situation in which prices will start rising on a consistent basis,” he said. “That will change the psyche of consumers and the market and raise inflation expectations because the minute you have expectations rising, it’s very difficult to take them down.”

A short-term housing surge?

Fuelled by record-low interest rates throughout the COVID-19 pandemic, Canadians embarked on a homebuying spree that saw housing market activity skyrocket over the last 18 months. While it may follow that rate hikes would lead to a cooldown throughout 2022, Tal also didn’t discount the prospect of a short-term rush on the market for last-gasp deals before those increases come into play.

“Rates rising is something that will introduce some sense of urgency to get into the market, realizing that the window is closing,” he said. “This is the nonlinear dimension of the housing market that we see all the time – that early in the process of raising interest rates, the housing market accelerates due to last-minute shoppers.”

The Bank’s last announcement on interest rates at the beginning of September surprised some observers by striking a decidedly optimistic tone, despite StatCan having reported the week prior that the country’s gross domestic product fell in the second quarter and the economy likely shrank in July.

Read next: “Transitory” an inaccurate description of current inflation spike – former BoC governor

Tal said that the Bank has room for further positivity in next week’s statement despite the lingering threat of inflation, with possible green shoots continuing to emerge for the Canadian economy.

“I think that the Bank will be relatively positive on the economy especially in 2022 as things go back to semi-normal with regard to the pandemic, the vaccine and all this business,” he said.

“They’ll be very encouraged. They’ll still talk about the potential increase in consumer spending due to the cash amount sitting on the sidelines; they’ll talk about business investments coming back, and even some opening of the global economy.”

While he shares the Bank’s view that current levels of inflation are temporary, Tal said that issues could arise towards the end of next year as wages and market demand potentially begin to increase.

“I think that the more interesting story will be the second half of 2022, where you see demands rising due to consumer spending and the possibility of continued shortage of labour as people will not go back to the labour market, [and] therefore wages may be rising,” he said.

That, he said, represented the “number-one” risk in terms of inflation: not supply chain issues, but persistent inflation due to labour market shortages and increasing demand.

“That’s something that will test the Bank of Canada and the Fed in the second half of 2022,” he concluded.