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  • Steve Huebl

Higher Interest Rates Needed to Tame Demand, Control Inflation: Macklem

Bank of Canada Governor Tiff Macklem reaffirmed that controlling inflation is the central bank’s “number one job.”

That’s why, on the heels of the country’s highest inflation reading in 30 years, the Bank of Canada will move ahead with further interest rate hikes, which Macklem said is the Bank’s primary tool to lower demand and manage inflation.

“The economy is now in a place where moving to a more normal setting for interest rates is appropriate. The economy can handle it,” he said during a virtual speech to the CFA Society of Canada on Thursday. “We know this will be a significant adjustment, and we fully intend to tighten policy in a deliberate and careful way, being mindful of the impacts and monitoring the effects closely.”

Macklem made the comments just one day after the Bank announced its first interest rate hike in over three years, which brings the overnight target rate to 0.50%.

Broadening inflation a “big concern”

Macklem acknowledged that the rise in inflation has been “larger than we expected six months ago,” and went into detail about the three elements that are driving inflation in Canada.

The first, he said, is the global shift toward goods and away from services that has played out during the pandemic, combined with pandemic-related disruptions to production and the supply chain.

Secondly, there has been a broadening of price pressures throughout the economy, which he called “a big concern,” given that it has become more difficult for consumers to avoid paying higher prices.

“It also increases the risk that households and businesses will begin to expect large price increases to continue and that this becomes embedded in long-term inflation expectations,” Macklem said. “The lesson from history is that if inflation expectations become unmoored, it becomes much more costly to get inflation back to target. So far, longer-term inflation expectations have remained well-anchored, and Canadians can expect us to use our tools with determination to keep them that way.”

Despite these concerns, Macklem pointed to the third element, which is the overall balance of demand and supply in the Canadian economy. Despite a loss of 200,000 jobs in January due largely to the Omicron variant, he said other data have “generally been robust,” and that the Bank “expects strong growth to resume.”

The BoC’s turn towards Quantitative Tightening

Macklem also provided some additional insight into the follow-up phase to the Bank’s Quantitative Easing (QE) program—the purchase of Government of Canada bonds throughout the pandemic—which will be Quantitative Tightening (QT).

At its peak, the BoC was purchasing up to $5 billion worth of bonds per week, which flooded the market with liquidity and helped keep fixed mortgage rates lower than they otherwise would have been.

The Bank announced an end to its QE program in October, and has since maintained its holding of bonds, which involves purchasing only enough bonds to replace those that are maturing.

“When we initiate QT, we will stop purchasing Government of Canada bonds,” Macklem said, adding that the Bank won’t actively sell bonds. About 40% of the Bank’s current $250-billion bond balance sheet will mature within the next two years.

“QT would complement increases in the policy rate, putting upward pressure on interest rates at maturities where households and businesses typically borrow,” he added. “But let me underline that our primary tool is the policy interest rate…And as we said in January, Canadians should expect a rising path for interest rates.”

Canadian Mortgage Trends Steve Huebl March 4, 2022


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