Canada’s central bank will hold rates in June despite the economy’s rising headwinds, according to BMO. In a report to investors, the bank warns accelerating core inflation is now above 3%—not just above the Bank of Canada’s (BoC) target rate, but also above its upper tolerance range. Slowing economic factors may bring down inflation eventually, and government policies may reinforce inflation—but until then, the BoC is expected to remain cautious.
“Core inflation at 3% and the economy avoiding the worst case scenario (for now) means that policymakers cannot afford to risk their credibility on inflation with a cut at this meeting,” warns Benjamin Reitzes, BMO’s Canadian Rates & Macro Strategist.
BoC Won’t Risk Another Inflation Mistake With June Rate Decision
The BoC-preferred CPI-Core has been above its 2% target rate for the past 54 months. It’s not slowing down either, but has now breached the 3% upper tolerance band for the central bank. By the central bank’s own definitions and goals, inflation has slipped out of its control and is now officially too high.
“The Bank of Canada has one mandate: 2% inflation. The persistent miss has to be top of mind for policymakers,” explains Reitzes.
He doesn’t see the BoC taking this lightly but considers a return to elevated post-pandemic inflation as its worst fear, and assumes they would fight it at any cost. Not everyone may agree, especially since the BoC disregarded accelerating CPI-Core when it made its last cut. But we digress.
BMO doesn’t expect a rate cut at the June meeting, expecting the monetary authority to err on the side of caution. However, Reitzes notes “the economic backdrop makes an increasingly compelling case to cut.”
Canada’s Economic Growth Outlook Weakens Ahead of June Decision
The Canadian economy is churning out some solid data points, but it isn’t expected to for long. Material growth is widely expected to be weak in Q2, with unemployment now at the cycle high of 6.9%—and likely to climb further, in their opinion. More importantly, trade negotiations may be going smoother but BMO expects a deeper impact from the fallout to materialize soon.
“Those factors should theoretically push inflation lower. Perhaps they will over time, but the Bank cannot be certain of that after misjudging the extent of the inflation pressure in the post-pandemic period. This is a mistake it can’t afford to make again, and the main reason we expect policy rates to be unchanged in June,” explains Reitzes.
He added, “However, we have yet to see material weakness in the data, leaving policymakers on the sidelines for now,”
Canada’s Federal Policies Could Drive Inflation Higher
Despite the ominous warnings and weak sentiment, there are reasons that inflation can get a boost in the near-term. Monetary inflation occurs when there’s an excess in demand relative to the supply of goods and services. Since credit can be issued faster than goods can be built, BMO sees several boosting factors in the next two years.
The biggest contributor may be Federal government policies. The bank notes a modest stimulative budget and a deficit of around 2% of GDP (up from 1.6%), is expected to provide an uptick. However, the bank notes most details won’t be available until the fall, and thus a bigger contributor to next year’s data.
In the meantime, Reitzes notes a modest boost from tax cuts and regulatory changes could be seen sooner. Tax cuts for some kick off this month, increasing disposable income, which should be reflected in Q3 GDP. They also see regulatory—or perhaps deregulation—changes to accelerate infrastructure projects, leading to higher expectations of rising demand-side stimulus.
Growth driven entirely by government stimulus may be the most ominous sign yet.