Vice-President, Chief Economist and Strategist
In its outlook this week, the OECD made distinctions between the current economic environment and the stagflation episodes of the 1970s. It pointed out that economies today are less energy intensive than they were 50 years ago. Central banks have also gained independence and built their credibility through decades of successful inflation targeting. As a result, longer-term inflation expectations haven’t strayed too much despite persistently high inflation of late. We think these distinctions matter. We also believe the government policy response to a recession would be entirely different today than it was back then.
Yet many refuse to put the parallels with the 1970s and 1980s to bed. In a paper released this week, Larry Summers argued that after correcting for the way US housing inflation was measured during the 1970s, inflation today isn’t much lower than it was back then. His conclusion was that the same kind of tough medicine used in the early 1980s will be required to tame inflation now. When then-Fed Chair Paul Volcker famously lifted interest rates to 20%, it triggered a double-dip recession.
Central banks today don’t believe that triggering a recession is necessary to regain control of inflation. However, we continue to see hawkish surprises. This week, the Reserve Bank of Australia announced a 50 basis-point hike, a move predicted by just three of the 29 forecasters surveyed by Bloomberg. The ECB pre-announced a 25 basis-point hike for July and opened the door to a 50 basis-point hike later. Some Governing Council members aren’t opposed to a 50 basis-point hike as soon as July. With energy prices continuing to push higher and a growing sense of urgency at the ECB, we’ve added another hike to our 2022 forecast and now expect the refinancing rate to end the year at 1%.
Closer to home, the Bank of Canada had to nuance its messaging a bit this week. Governor Macklem is still warning about the possibility of “more forceful” action. But at the same time, the BoC’s Financial System Review didn’t hide the fact that higher interest rates will be painful for some households. Its simulations show that mortgage payments could rise by an average of 30% for borrowers who took out a five-year mortgage in 2020 or 2021. Households that stretched the most and were lured by low variable rates could be looking at a 45% jump. This would increase monthly mortgage payments by over $1,000. And that’s assuming mortgage rates are around 4.5% at renewal. If Macklem were to heed Larry Summers’s advice, things would get ugly pretty fast.
Thankfully, the Bank of Canada is still focused on engineering a controlled slowdown. And as we discussed in an Economic Viewpointon Wednesday, a controlled slowdown is also what we envision for the housing market. We’ll discuss the consequences of this housing slowdown in an analysis next week. In short, Canada’s economy is more deeply tied to rates and housing than ever. As a result, we still believe this will reduce pressure on Macklem to take the overnight rate above 3%, let alone set off a Volck-ano.
Read the full commentary: No Rate Hike Volck-ano for Now