Picture: HDClipart.com

That thump you heard wasn’t the Easter bunny hopping down the bunny trail.  It was Bank of Canada Governor Tiff Macklem delivering a round-house boot to the rear ends of borrowers.

The BoC hiked the overnight rate to 1.0% from 0.50% due to rising inflation with further increases promised.

The monetary policy statement claimed that CPI is climbing higher and faster than the policymakers expected due to soaring oil, natural gas, and other commodity prices in moves exacerbated by supply chain disruptions and the Russian invasion of Ukraine.

The statement proclaimed (as usual) that the BoC will use its monetary policy tools to return inflation to target and keep inflation expectations well-anchored.

The BoC is on the job.  In his April 13 press conference, Mr Macklem declared that the Bank’s primary focus is inflation.


Should you be?

Six months ago, the BoC professed to be concerned about inflation but were comfortable concluding higher CPI was due to pandemic-related factors.  In addition to rising prices from supply chain disruptions, they believed inflation gains were due to higher airfares, used cars, and hotel prices.  Despite the increases, policymakers were convinced inflation would return to the 2.0% target by the end of 2022 They ow believe inflation won’t reach their target until the end of 2024..

Today, Russia’s invasion of Ukraine is the new pandemic, and the BoC is unsure how it will impact Canadian growth or inflation.  They anticipate higher exports and increased investment, while higher commodity prices may increase production costs.

The BoC fears that Canadians will believe inflation has become entrenched if inflation does not start to fall.  To prevent that from happening, the BoC plans to raise rates further, hoping the action will reduce spending and cool the overheating economy.

Great Idea!  But why wait?

The media believes it’s a big deal.  A CBC headline shouts, “Bank of Canada hikes rates by biggest amount in 20 years.” The Globe and Mail describes the hike as “oversized.”  The National Post reminds readers that it is the first 0.50% hike in 22 years.

The headlines are the epitome of “hyperbole.”

The BoC was very aggressive in 2020, so why are they so timid now? 

They slashed interest rates by 1.50% in three moves between March 3 and March 26, 2020, as part of a multi-pronged effort to support the domestic economy from the impact of the pandemic and a steep plunge in oil prices

 In March, the Bank basically admitted that the economy had fully recovered from the pandemic.  On April 6, the BoC revised its “guess” of the “nominal neutral rate” to 2.0-3.0% from 1.75-2.75%.

They know interest rates are too low, so they should raise the overnight rate to its March 2020 level of 1.75% immediately and then focus on balance sheet reduction and fighting inflation.

That won’t happen.

The Fed is in the same boat as the BoC.  Newly converted rate hawk, Jerome Powell, could surprise markets with a more robust rate hike than the 0.50% expected on May 3.  A flock of Fed officials, including Vice Chair Lael Brainard are sending up a barrage of “trial balloons” as the speculate about a rapid pace of balance sheet reduction, and warn of 1974-era inflation levels.

St Louis Fed President James Bullard believes the Fed is behind the inflation curve.  In an April 7 speech, Mr Bullard compared  two interpretations of “behind the curve”.

The first used a  “Taylor-type” monetary policy rule that incorporated a value for real interest rates, parameters for describing the reactions of policymakers to deviations of inflation from target, and a value for describing the policymaker reaction.  Yes, its Greek to me, as well.

In a nutshell, the Taylor-type rule says the current policy rate is about 0.300 bps too low. 

Then he compared it to “Credibility and forward guidance” which suggests indications of future policy rate increases are incorporated into current financial market pricing before policy actions are taken.  This measure suggests that the Fed is not as far behind the curve, but still needs to raise rates.

Source: Fed Reserve Bank of St Louis

The Fed was just as busy as the BoC in March 2020, and they slashed interest rates by 1.50% in just two moves (March 3 and March 16).

The strength of the post-pandemic recovery, which has driven the US unemployment rate down to 3.6% and lifted inflation to 8.5%, is all the evidence the Fed needs to fully erase the pandemic rate cuts.  A 1.50% rate hike on May 3 can be easily justified, but it won’t happen.

The Canadian dollar managed to rally following the BoC decision, but USDCAD needs to break below 1.2440 or suffer more 1.2440-1.2840 range trading.

The Keister bunny may have kicked borrowers in the pants, but if the BoC were truly serious about fighting inflation, the kick would have been in a more sensitive region.