Posthaste: Why some economists think the Bank of Canada is about to make a mistake

It’s been awhile since there’s been this much drama around a Bank of Canada rate decision.

Just a few weeks ago the central bank was widely expected to hold fire on interest rates for the rest of the year. Then governor Tiff Macklem spoke from the sidelines of an International Monetary Fund meeting and something shifted.

Macklem said higher energy prices from the Iran war were boosting economic growth and increasing the risks of higher inflation ahead. This followed a more hawkish tone from the bank since early September.

His comments pushed markets to increase their bets to 76 per cent that the bank would raise its policy rate to 2.5 per cent this Wednesday and convinced many of the country’s top economists to change their calls.

“We can’t see why Macklem would have hastened to make these comments at the IMF meeting, just before the Bank’s media blackout, other than to signal an October hike,” said CIBC’s chief economist Avery Shenfeld in a note.

Their calls may have changed, but not their minds.

Royal Bank of Canada chief economist Frances Donald said her team’s expectation of a rate hike Wednesday is not because they think there is a need for such a move, but because of policymakers’ recent communications.

In RBC’s view “the case for patience is strong.”

They see no evidence that higher energy prices are bleeding into broader inflation and though the Canadian economy is improving, it is still not strong. The housing market is stuck in a downturn and gross domestic product data out this Friday should confirm that growth slowed in the third quarter.

RBC also argues that bond yields that have risen more than 40 basis points over the past three months have already done some of the central bank’s work in tightening financial conditions.

Shenfeld said CIBC would “respectively beg to differ” with a rate hike if the central bank decides to go that way tomorrow.

“Our worry that this could be a policy error is tied to the fact that we aren’t yet sure that ANY rate hikes will be warranted in the coming year, so moving early could be a step that the Bank comes to regret,” he wrote.

“The risks of waiting, in contrast, appear to be more limited.”

The weeks after the U.S. mid-term elections in November could resolve many of the uncertainties now facing the Canadian economy regarding energy inflation and trade relations, he said.

The U.S. could reach a post-election deal with Iran that lowers oil prices. There is also a chance that trade tensions get worse, in which case the Canadian economy would need the support of lower interest rates.

David Rosenberg, president of Rosenberg Research & Associates Inc., makes no bones about it. He finds it “astounding” that markets are pricing in a rate hike Wednesday as a “virtual certainty” and upping the odds of another move in December.

Rosenberg argues that the Bank of Canada has no control over imported inflation from higher energy costs, and cautions that the economy could end “up being the sacrificial lamb in this senseless fight against inflation that has zero to do with the state of domestic demand.”

“By piling on this cost shock with rate hikes, the recession that we did not get when we were supposed to back in 2021 and 2022 will emerge as a primary risk for 2027,” he said.

Six of the seven members of the C.D. Howe Institute’s monetary policy council, which includes economists from Canada’s largest banks, called for the Bank of Canada to holds it rate at 2.25 per cent tomorrow.

“Members saw little evidence of broader price pressures and, from that perspective, found it difficult to make the case for a hike, which most did not,” said the institute.

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Curious about what’s been driving the Canadian dollar lately?

This chart by National Bank of Canada shows the forces whipsawing the loonie. After months in negative territory, the loonie’s correlation with oil recently turned positive, said National Bank senior economist Kyle Dahms. But that influence remains weak compared with gold and two-year yield spreads.

Expectations of a Bank of Canada rate hike tomorrow and a Federal Reserve hold has helped reverse some of the currency’s earlier losses, but its recovery is vulnerable to changes in rates and commodities, he said.

National Bank remains cautious on the Canadian dollar for the rest of this year. Appreciation will depend on the easing of trade tensions and narrowing of Canada’s yield disadvantage.

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Today’s Posthaste was written by Pamela Heaven with additional reporting from Financial Post staff and Bloomberg.

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