Managing Director and Head of Macro Strategy
After insisting that there would be some kind of immaculate deceleration in inflation, officials around the world are now offering long overdue mea culpas. US Treasury Secretary Yellen echoed past comments from Fed Chair Powell that American policymakers had misjudged the persistence of price pressures. The Bank of Canada for its part has been acknowledging for some time that it got things wrong with regards to inflation and is now playing catch-up.
To make up ground, the Bank of Canada hiked rates another 50bps this week, taking its policy rate to 1.50% and cementing this hiking cycle as the fastest in the inflation targeting era. The Federal Reserve is set to unleash a similar-sized rate increase later this month. Even central bankers in economies like the eurozone are discussing the need to act forcefully in the near term to restrain inflationary tailwinds.
With 20/20 hindsight, it’s easy to criticize policymakers for a series of missteps that left them well behind the curve. Quantitative easing programs were allowed to continue for too long. Even in Canada, where the Bank of Canada’s asset purchase program was halted months before other central banks’ bond buying sprees, quantitative easing saw the Canadian central bank hoover up more than 40% of the sovereign bond market.
The policy rate in a number of jurisdictions was also clearly left too low for too long. That was in part because central bankers were slow to recognize the scope and persistence of supply constraints. But it was also partially due to an unforced error in which officials tied their hands with overly specific forward guidance about the triggers for tighter policy. The end result has been an overheating in a number of global economies which has contributed to the excess inflation emanating from factors out of central bankers’ control, like global commodity prices and supply chain disruptions.
Bank of Canada officials and their global peers are now taking steps to remediate the situation. They’re also being more honest about the risks surrounding the path forward. Inflation has run high for so long that there’s a realistic possibility high inflation will become embedded in expectations. That would make the task of bringing price pressures back down all the more difficult. The worst-case scenario would be if the public were to lose faith in monetary officials’ ability to bring inflation back down. The building blocks of low and stable inflation are anchored inflation expectations and central bank credibility.
On that front, the Bank of Canada has stepped up its hawkish rhetoric in a bid to assure everyone that it’s 2% inflation target is still sacrosanct. By mentioning that policymakers could act even more forcefully if needed, this week’s Bank of Canada statement opened the door to an even more aggressive hiking cycle. Central bankers in other parts of the world are taking a similarly hawkish approach. Whether or not it’s just jawboning, it should help anchor inflation expectations and build back credibility. There’s still a chance to reduce inflation without triggering a recession. It’s a slim chance that hinges in part on the public having confidence in policymakers, but it’s a chance nonetheless. So while higher interest rates will pinch the pocketbooks of households and businesses, the change in tack towards tightening financial conditions is what’s needed to guide inflation back down and get the economy operating efficiently again. Better late than never.
Read the full commentary: Better Late Than Never