WHY TIFF MACKLEM IS WILLING TO RISK A RECESSION TO CRUSH INFLATION

Bank of Canada governor Tiff Macklem might be struggling to convince the broader public that inflation will return to two per cent ever again, but he’s managed to change the perception of what counts as a big interest-rate increase.

Macklem raised the benchmark interest rate a half-point on Oct. 26, lifting the target rate on which banks base their lending to 3.75 per cent. It was widely interpreted as a softening of the hard line the central bank had drawn on inflation.

That was then. The Bank of Canada’s previous interest-rate increase in September was three-quarters of a percentage point, and the one before that was a full percentage point. So, Macklem had to work this week to convince people that a half-point lift counted as a big deal. “This is a larger-than-normal step, a big step,” he told reporters when asked why he didn’t lift borrowing costs by three-quarters of a percentage point, which is what most currency traders and bond investors appeared to have been expecting.

Yields on two-year Canadian government debt dropped below four per cent for the first time in two weeks after the Bank of Canada pulled up short of market expectations, Bloomberg News reported. Meanwhile, the dollar was little changed, trading at about 74 cents U.S., which might reflect an assessment among traders that the Bank of Canada has joined the Reserve Bank of Australia in releasing the safety brake it had applied earlier this year to keep inflation from racing out of control.

“By hiking less than consensus forecast, the Bank of Canada’s policy decision is reinforcing the notion of a more generalized central bank pivot,” Mohamed El-Erian, the widely followed chief economic adviser at Allianz SE, said on Twitter, adding that by “pivot,” he meant market prices suggest investors see the pace of rate increases slowing, “as opposed to prior definitions of cut and pause.”

Indeed, Macklem was clear that a cut isn’t on the agenda, even though the Bank of Canada’s new economic outlook has growth stalling soon, if it hasn’t already. (The central bank predicts economic growth will slow to 0.5 per cent in the current quarter, and that gross domestic product will expand only 0.9 per cent in 2023.)

The central bank’s policy statement explicitly said “the policy rate will need to rise further,” because inflation is around seven per cent, way off the two-per-cent target. Most Bay Street and Wall Street economists reckon that means the benchmark rate is headed to at least four per cent, and maybe as high as 4.5 per cent before year-end. In the past, the Bank of Canada has opted to pause on its way to a new interest-rate setting to gather more information about how monetary policy is affecting the economy.

But Macklem appears unwilling to risk giving inflation any oxygen. At the press conference, he was asked whether the trajectory for interest rates from here would be “data dependent,” which would imply taking time to assess changing conditions, or whether considerations were simply about “pace and scale,” which would imply the only question on the table when policymakers next gather to set interest rates in December would be, how high?

“People don’t necessarily believe inflation is coming down very quickly,” Jean-François Perrault, chief economist at the Bank of Nova Scotia, told the Financial Post’s Larysa Harapyn after the central bank’s policy announcement on Oct. 26. “So, how is it possible for the central bank to stop raising rates at 4.25 per cent when inflation is still above six per cent? That, I think, is the bigger challenge that they’ve got. How do they slow down, how do they stop raising rates when inflation is still so far away from their target?”