Bank of Canada wary of signs of a turning point in economy, as it hikes key interest rate again

As we've seen in the recent surge in climate disasters, the effectof a gradual increase in temperatures does not necessarily result in agradual impact on people's dailylives. Nor does it affect people equally.

Wednesday's Monetary Policy Report from the Bank of Canada offered a similar lesson, as the central bank once again warned that the poor and over-borrowedwere likely to suffer more from both high inflation and the high borrowing rates needed to bring down stubborn inflation.

While he admitted that the latest quarter-point hike in its key rateto fiveper cent would hurt many people,Bank of Canada governor Tiff Macklem warned that he remained wary of overshoot with the possibility thatthe lagging effects of a long series of interest ratehikes could kickin suddenly and putthe economy into reverse.

Unnecessary pain?

"We're trying to balance the risks of under- and over-tightening," Macklemsaid in answer to a reporter's question at Wednesday's news conference in Ottawa. "If we do more than we need now, it's going to be unnecessarily painful."

Asked repeatedly by reporters why a string of 10 interest rate hikes had not had a stronger impacton inflation, including food and house prices,Macklem and senior deputy governor Carolyn Rogers cited a number of effects, including a housing shortage, a strong labour marketand the post-pandemic surge in immigration that recently sent Canada's population to the 40-million mark.

But the other thing that may be "buffering" the effects of higher rates are forces similar to the K-shaped recovery that we saw after the COVID-19 pandemic meltdown. Just as we've seen in recent climate disasters, not everyone is affected the same.

"We deal in a lot of aggregate numbers and averages,but we know that inflation and interest rates affect people very differently," Rogers said. "In particular, we know ... that the most vulnerable Canadians are the ones that are hurt most both by inflation and by higher interest rates."

While news stories quite fairly focus on the plight of the worst off,a majority of Canadians remain in financial good shape, she said. And those better-off Canadians are able tokeep spending even as prices rise.

"There are two things that are helping buffer many households from both inflation and interest rates, and that is the savings they accumulated over the course of the pandemic. You can see three-quarters of households have accumulated quite a bit more savings thanthey had prior to the pandemic," Rogers said, citing the Monetary Policy Report (MPR), which contains many interesting graphs andcharts.

"The other thing we think is supporting confidence and buffering Canadians from some of the impacts is the strong labour market," she said, adding that people are not afraid of losing their jobs.

Central banks have been wrong

While Macklem and Rogers emphasized the view thatwe are heading to a slow and smoothsoft landing without heading to recession, anMPR outlook is never complete without a mention of the downside risks.

"It's ridiculous to think that a quarter-point rate hike [on Wednesday] would make the difference between starting a recession and avoiding recession," longtime Edmonton financial analyst and author Hilliard MacBethwrote in a social media post this week.

But of course there are many examples of what we might call the last straw effect, when afinal increase in rates orthe final rise in global temperaturescan lead to a cascade of consequences. The impossible thing to know in advance is when the moment is reached. Certainly both the Bank of Canada and the U.S. Federal Reserve havegotten sudden changeswrong in the past.

Many economists have suggested that central banks around the world have gone too far, too fast in hiking ratesand that the well-known lagging effect of previous sharp rate hikes could come all at once.

WATCH | Bank of Canada hikesrateagain and isn't ruling out more increases:

Bank of Canada raises interest rate to 5% and doesn't rule out more hikes

11 months ago

Duration 2:07

The Bank of Canada has raised its benchmark interest rate to 5 per cent, saying inflation and excess demand remain stubbornly high. Many Canadians with mortgages are feeling the pain, with some paying double what they did just a few years ago.

Canadian author Malcolm Gladwell wrote a whole book about the concept inThe Tipping Point,"that magic moment when an idea, trend or social behaviour crosses a threshold, tips, and spreads like wildfire."

In the climate context, that wording might be disquieting in ayear when the hectares burned in Canadian wildfireshit a new "magic moment."

In the Canadian economy, there are a number of negative indicators that could come together to cross a threshold.

Hints of a June slowdown in home sales couldbe confirmed in Friday's latest real estate data. A sharp fall in U.S. inflation on Wednesday, new rules to cut risk on mortgage extensionsand this week's announced decline in sales at Aritziaare potential signs that the economy may be reachinga turning point.

Growing signs of a slowdown

"Increased missed payments on products like credit cards and auto loans are a concern," Rebecca Oakes, vice-president of advanced analytics at Equifax Canada, said in a release of new data last month.

The average interest rate that mortgage holders are paying is still well below what you'd pay if you had to renew now. As each person's renewal comes due, they will have to take money from their consumer spendingto debt repayment.

"The impact of the rate hikes were felt in markets (especially bonds) in real time, but the real economy is only just starting to feel the real effects of the tightening of the credit channel," Cullen Roche, a well-known U.S. money manager, said in a social media post.

This week, inflation inChina a country blamed for contributing to global price hikes due to its pandemic industrial shutdowns fell to zero, with producer prices actually shrinking.

Former Bank of Canada governor Stephen Poloz used to say he had to steer by looking in the rearview mirror.

On Wednesday the current governor said while there may still be more rate hikes ahead and little chance of interest rate cuts, he'llwatch the economy meeting by meeting in order to be ready for the unexpected.