Meanwhile, Canada Sacrifices Housing Bubble To Curb Inflation

The Bank of Canada escalated its battle with inflation Wednesday, raising rates by another 75bps.

The move followed a 100bps cannon shot in July, and helped cement the BoC as a particularly hawkish bunch in a world full of hawks, even as some were keen to cite an allusion to the lagged effects of policy tightening as evidence that “the end is in sight.” I doubt seriously that’s the BoC’s preferred interpretation of the September statement.

In July, the bank delivered a stark (and very explicit) warning about the risks associated with a wage-price spiral. On Wednesday, the BoC took no solace in moderating headline inflation, which recently receded to 7.6% thanks to falling gas prices. As the simple figure (below) shows, that drop was very small compared to the scope of the problem.

“Inflation excluding gasoline increased and data indicate a further broadening of price pressures, particularly in services,” the bank fretted, in the new statement, noting that their own measures of core inflation “continued to move up” over the summer, while gauges of short-term inflation expectations are still elevated.

“The longer this continues, the greater the risk that elevated inflation becomes entrenched,” the bank remarked.

Wednesday’s hike brought the total amount of tightening in 2022 to 300bps (figure below). The Canadian economy, the bank said, still has “excess demand” and the labor market remains very tight.

Policy is now in restrictive territory, but it’s hardly draconian. Neutral is somewhere between 2% and 3%. In all likelihood, rates will go to 4% before the BoC stops.

“Given the outlook for inflation, the Governing Council still judges that the policy interest rate will need to rise further,” the bank said, adding that quantitative tightening “is complementing increases in the policy rate.” “As the effects of tighter monetary policy work through the economy, we will be assessing how much higher interest rates need to go to return inflation to target,” the statement read.

Some interpreted the long and variable lag reference as marginally dovish. I’d be inclined to call it a polite (i.e., perfunctory) nod to the fact that eventually, rate hikes will slow. That’s just stating the obvious.

The read-through for the housing market of ongoing tightening is ominous. Home prices in Toronto notched a fifth straight decline last month, the longest streak in half a decade and variable mortgage rates at RBC are up to 4.5%. The bank expects home prices to fall double-digits from recent highs by early 2023, in what could be the most acute housing correction in the country’s recent history. Sales, the bank suggested, may fall by a cumulative 42%, more than the decline seen during the financial crisis years.

In June, benchmark home prices in Canada notched the largest monthly drop in at least 17 years (figure below). They fell again in July by a similar amount, but were still up double-digits on a non-seasonally adjusted, 12-month basis.

Sales fell more than 5% in July from the prior month, and more than 29% from 2021. Desjardins in August warned that average home prices could drop by a quarter over the next 18 months.

Policymakers on Wednesday shrugged off a weaker-than-expected Q2 GDP print, and described the recent pullback in housing as “anticipated.” The bank declared the pandemic-era housing boom “unsustainable.”

“Big picture, the bank is maintaining optionality here,” TD’s chief Canada strategist Andrew Kelvin wrote. “We thought the communiqué would be a bit more explicit about moderating the pace of future rate hikes,” he added. “Instead, the bank is falling back on data dependence with no additional guidance, which suggests to us that the bank is itself uncertain about the endpoint for the overnight rate this tightening cycle.”