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The Bank of Canada’s interest rate ruling on Wednesday did not lead to cuts, but it did provide additional clues about the direction the central bank believes interest rates might take.
The bank kept its overnight interest rate at 5%, but raised something else: its neutral nominal interest rate.
The fair rate is the rate at which central bank policy neither stimulates nor slows down the economy.
It’s necessarily the Goldilocks interest rate, said Sheila Block, an economist and research associate at the Canadian Centre for Policy Alternatives. This is where the economy may continue to grow, but inflation will spiral out of control.
The fair rate is now estimated at between 2. 25 and 3. 25, down from 2 or 3 in the central bank’s last report.
While the unbiased rate is rarely good science (which is why it’s presented as a band), it’s still a vital adviser to the central bank’s financial policy and one that Canadian consumers, especially those with debt, should keep a close eye on. Block said.
“Central banks are looking to succeed at that sweet spot where their rate decisions don’t cause a recession and, by the same token, don’t fuel inflation,” he said.
The unbiased rate hike indicates that the Bank of Canada believes interest rates will reach a higher-than-expected point once the cuts are complete, Block said, the unbiased rate tells us nothing about the timing or speed of the cut.
“It shows how much the bank thinks rates can come down. And what they’re saying today is that the bank believes rates can’t come down as low as they had imagined in the past,” he said.
Bank of Canada Governor Tiff Macklem said at a news conference on Wednesday that the standalone interest rate does not have a primary impact on the bank’s real-time deliberations.
“It’s a detail in our models,” he said, but it doesn’t have much influence on “real-time financial policy. “
“The unbiased thing is where our long-term policy would be, when inflation is on target, the output hole is closed, and there are no shocks. “
Canadians have grown accustomed to low interest rates before the COVID-19 pandemic, Block said, but any hope that rates would return to pre-pandemic levels after the central bank received inflation below “is long gone. “
“Now, how much higher are they going to be?”
The long-term economic environment is changing due to several points that will require a higher standalone interest rate, he said. These are accompanied by emerging public debt and investment requirements related to climate change.
Despite the fair rate hike, the bank’s projection remains relatively optimistic, given that for many market watchers it could simply be higher, Royce Mendes, managing director and head of macro strategy at Desjardins, said in a note.
Block is one of those who believes the unbiased rate will increase even more.
“I think there are a lot of inflationary points that have accelerated. So, it will stay at 2% (inflation),” he said. The central bank’s inflation target is 2 percent.
CIBC’s Avery Shenfeld and Ali Jaffery wrote in an April 5 report that they expect the Bank of Canada to raise its fair rate this week and that they expect the U. S. Federal Reserve to raise its own fair rate.
However, measuring where the unbiased rate will be a few years from now is “fraught with pitfalls,” they write, “and we possibly won’t know until we see how the economy fares as we get closer to it. “
They added that the Bank of Canada has been hesitant to say that the unbiased rate could simply increase.
Canada’s unbiased rate has traditionally been lower than the U. S. for about a decade, Shenfeld and Jaffery write, and they expect this gap to continue, largely due to the fact that Canadians are on average more indebted than their southern neighbors. .
This report via The Canadian Press was first published on April 10, 2024.
Rosa Saba, The Canadian Press