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Bank of Canada Governor says rates may be “sufficiently restrictive”

Governor Tiff Macklem said rates could be “sufficiently restrictive” in a speech this afternoon, implicitly raising the bar for further increases in the Bank of Canada’s incredibly-aggressive post-pandemic monetary tightening cycle.

In the latest Economic Progress Report, delivered at the Calgary Chamber of Commerce, Macklem said “Monetary policy is working, and inflation is coming down. But we still have some way to go to restore price stability. With past interest rate increases still working their way through the economy, monetary policy may be sufficiently restrictive to restore price stability. However, Governing Council is concerned about the persistence of underlying inflation. Inflation is still too high, and there is little downward momentum in underlying inflation”. He warned “We are prepared to take further action. But we don’t want to raise our policy rate more than we have to.”

Echoing sentiments expressed in yesterday’s statement, Macklem said “excess demand in the economy has diminished substantially,” as rates have climbed and growth has slowed, and “This should reduce price pressures, leading to lower inflation”. “The weakness in second-quarter gross domestic product largely reflected a broad-based slowing in consumer spending and a decline in housing activity. The softening in household spending on goods was most pronounced on larger items people often buy on credit, such as furniture and durables for outdoor recreation. Together with the decline in housing activity, this points to the moderating effect higher interest rates are having on household spending. Consumption of services also slowed, which may indicate that the effects of tighter monetary policy are broadening from goods to services”.

In a Canadian-style victory lap, he said “So far, we’ve been able to cool demand without unemployment spiking. As I outlined last November, the fact that job vacancies were at a record high meant we had scope to cool the labour market without causing a large surge in unemployment. Nearly a year later, we can see that job vacancies have indeed fallen significantly, with only a small increase in the unemployment rate,” – but also worried about rising costs, saying “Wage growth, in contrast, has yet to show clear signs of moderation”.

Taking direct aim at commentators who have suggested that rate increases are themselves the biggest contributor to higher living costs and that inflation is already essentially on target, he said “It’s true that if we hadn’t raised interest rates, mortgage costs might be lower today, but inflation throughout the economy would be a much bigger problem for everyone”.

The Canadian dollar reacted slipped in the moments after the comments were released as traders ratcheted expectations for an autumn rate increase modestly downward, and pulled the first implied rate cut slightly forward in 2024.

As previously articulated, we think the Bank of Canada’s tightening cycle has come to its logical conclusion, but we also expect Macklem and his colleagues to deploy relatively-hawkish rhetoric in the months to come as they seek to prevent a new melt-up in consumer spending. This dynamic should help put a floor under the loonie, even as weakening economic fundamentals argue for lower valuations.

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