How concerned is the Bank of Canada about inflation?

CIBC's Tal says a new COVID-19 variant likely weighed heavily on the BoC decision not to increase rates

How concerned is the Bank of Canada about inflation?

While the threat of inflation has rarely been far from the headlines in recent weeks, the Bank of Canada opted against changing its tune on interest rates in its final policy rate announcement of the year on December 08.

That statement saw the Bank hold firm on its forecast that the benchmark rate is likely to begin rising sometime in the middle quarters of 2022, belying market speculation that a January hike could be in the cards.

The Bank is “closely watching” the inflation issue, according to the announcement, which emphasized that an elevated level is likely to remain throughout the first six months of next year before returning to its target of around 2% in the second half.

Canadian Imperial Bank of Commerce (CIBC) World Markets managing director and deputy chief economist Benjamin Tal (pictured top) told Canadian Mortgage Professional that the Bank had taken a careful approach to the inflation question by indicating that they were monitoring the situation but not moving too quickly on it.

“The only debate was whether or not they would be hawkish enough to hint that they would move in January, but there was enough language there about the virus, [continuing] slack in the economy, the temporary nature of inflation… and then suggesting that they would like to see rates rising in the second quarter of 2022,” he said.

“What the Bank of Canada believes they will do at this point is [raise rates in] April. They had a chance to revise that and give a hint that they will go earlier, and they chose not to. To me, that’s a very strong statement.”

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That move showed that the Bank was “not panicking” over inflation, said Tal, even if it now believed that the issue may take longer to rectify than it had initially planned.

The Bank noted that the Canadian economy was buoyed by significant momentum into the fourth quarter of the year, with strong job gains bringing the employment rate “essentially back to its pre-pandemic level” even if current vacancies remain high.

While the market is anticipating about five Bank rate increases over the course of 2022, Tal said he expected that number to be slightly lower, particularly given the risk of upending the recovery of a still-fragile economy.

“The most important question is whether or not the Bank of Canada will follow what the market is pricing in. I don’t think that the Bank is ready to move so aggressively in 2022,” he said.

“I think there is a risk that if you move too quickly you can derail the economy. The market is pricing five moves; I think they will go [with] three.”

That’s likely to entail three quarter-point increases in 2022 and a further three the following year, according to Tal, with the possibility of reaching its 2% target by 2024.

The emergence of a new strain of COVID-19, the Omicron variant, also could have played a significant part in influencing the Bank’s decision not to announce a possible rate hike in January.

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That development has seen numerous countries implement new regulations and travel restrictions, with the Bank registering the “renewed uncertainty” caused by the outbreak.

Tal said that the new variant was one of the main reasons that the Bank had opted against pushing forward its timescale on rate increases. “I think that if we didn’t have Omicron and uncertainty regarding the virus, maybe they would be more open to start moving in January,” he said.

“If you didn’t have the uncertainty regarding COVID, if the number of cases were down, then I think you could justify moving in January.”

With the Bank having indicated in its previous statement in October that the days of record-low interest rates would soon be ending, a flurry of activity in Canada’s housing market was mooted as would-be buyers rushed to secure deals before rate hikes.

Tal said that he expected that trend to continue into the opening months of next year, although the market would likely cool off markedly after that.

“I think that we’ll see basically what we’ve seen over the past few weeks – namely that people are getting into the market… That will last into the spring and I think after that, we’ll see notable slowing in overall activity,” he said.

“What we’re doing now is basically borrowing activity from the future. The future eventually will arrive, and I think that will be the second half of next year.”