By Michael O’Neill
The Bank of Canada (BoC) took another bite out of inflation. On June 1, they hiked the overnight rate to 1.5% from 1.0%.
Is it working? Not yet, and probably not any time soon.
On April 13, BoC Governor Tiff Macklem proclaimed, “inflation is too high.” He announced a 0.50% rate hike and then said, “we need higher rates to keep the economy in balance and bring inflation back to its 2.0% target.” At the time, Canada’s March inflation rate was 6.7%.
Inflation ticked higher in April, rising to 6.8% y/y. Rather than looking toppish, inflationary pressures increased across all eight major components. The May results are likely to be uglier and could top 7.0% y/y, especially if oil prices continue to climb.
The BoC statement noted that the economy is strong and clearly operating with excess demand. It also said that job vacancies are elevated, and companies are reporting widespread labour shortages.
The BoC claims the neutral rate is between 2.0% and 3.0%. That’s the rate the BoC says “that prevails when an economy’s output is at its potential level and inflation is at the central bank’s target, after the effects of all cyclical shocks have dissipated.”
If they believe what they say about the strength of the economy, why are they so timid? Why not raise rates to 2.5% immediately?
They only cut rates to close to zero to help stimulate the economy during the pandemic. The pandemic is over and so is the need for low rates.
The BoC failed to react to higher price pressures in the second half of 2021, insisting, like the Fed, that rising inflation was transitory, thereby allowing the gains to get out of hand.
Mr Macklem is keenly aware of the need for sharply higher interest rates. He told the Senate Finance Committee that rates would need to rise above the neutral rate and remain there for a period of time in order to tame the inflation tiger. His actions do not match his words. The BoC is filling a very deep hole with a teaspoon, while leaving the front-end loader idle.
Photo: Wikimedia/IFXA Ltd
The central banks of the “so-called” commodity currency bloc, the Reserve Bank of Australia and the Reserve Bank of New Zealand are also bumping rates in 0.50% increments. They face similar issues as the BoC, and their policy statements are eerily similar.
The Canadian dollar responded tepidly to the latest rate hike. Instead, intraday price action was determined by S&P 500 moves which have been the case for the past few months.
Nevertheless, the Canadian dollar finished May as the second-best performing G-10 major currency, even though the S&P closed down 0.56%. That’s because West Texas Intermediate (WTI) oil soared nearly 19% from its May low.
Russia’s invasion of Ukraine threw a monkey wrench into the global energy business. Western leaders were rightfully outraged at Putin’s aggression and have been slapping sanctions after sanctions on Russian politicians, business leaders, and energy.
This week, the EU imposed a ban on about two-thirds of Russian oil imports with plans to raise the level to 90% by year-end.
The EU imported about 23% of its oil needs from Russia in 2021, so finding an alternative source is crucial.
EU leaders are searching for a country with massive proven reserves (Canada has 166 billion barrels in the oilsands) and a stable government (Canada) to provide a reliable source of oil.
In that environment, investors should be tripping all over themselves to throw money into Canadian energy projects and, by default, the Canadian dollar.
Alas, it is not to be.
The Federal government killed that golden goose, then barbequed it on a solar-powered grill while singing “kumbaya.”
To say Canada is rabidly anti-oil is an understatement.
Last November, the government issued a press release. It started with, “Canada announces commitment to end new direct public support for the international unabated fossil fuel sector by the end of 2022.”
The release noted plans for “capping and reducing pollution from the oil and gas sector to net zero by 2050. In addition, they promised that the “government will set 5-year targets and will also ensure that the sector makes a meaningful contribution to meeting Canada’s 2030 climate goals.
It was a polite way of telling oil sector investors that they were not welcome. Boy, don’t they look silly.
Canada should be awash in foreign investment, and USDCAD should be trading below 1.2000. That’s not happening.
Bank of Canada Deputy Governor Toni Gravelle noted in a speech on May 12, that they expect the “recent increase in commodity prices to boost the level of business investment in Canada by less than half of what our models generally predict based on historical relationships.”
Canada used to be able to mitigate rising inflation by importing cheaper foreign products with an oil-fueled firmer Canadian dollar. That won’t be the case this time.
Interest rates are being hiked, but policymakers have fumbled the ball.