Bank of Canada faces credibility test in political storm over inflation


(Bloomberg) — If worrying about an overheating economy wasn’t enough, Bank of Canada governor Tiff Macklem is entering a pivotal six-week battle against inflation with an unexpected new problem: questions about his own credibility.

The 60-year-old central banker has been targeted by prominent opposition Conservative Party politicians, who have cast doubt on his commitment to the fight. And while most economists and experts have dismissed the criticism as frivolous, the attacks come at a tense time.

The Bank of Canada is in the midst of a shock-and-awe campaign to curb inflation, hoping to bolster public confidence that it is serious about tackling the problem. The more credible the central bank is deemed to be, the more price expectations will be reined in — and the more likely it will be for a soft landing.

Macklem is expected to continue with three consecutive gains of half a percentage point over a three-month period. The first jumbo walk came in mid-April, chances are the second will come this week and a third probably in the first half of July.

“If Tiff is concerned about his credibility, what he should probably do — and this is the unfortunate thing — is probably overdo it, in terms of rate hikes and a little more risk,” Chris Ragan, director of the public policy school told McGill University in Montreal, on the phone.

Inflation Battle

The bank’s key rate, which started the year at a record low of 0.25%, is expected to hit 2% at its July 13 meeting. It’s a frontload of violence to convince households and businesses that the inflation spike won’t last long before they start to calibrate their expectations for wages and prices higher.

The markets seem confident that Macklem will succeed.

After the three oversize moves, the Bank of Canada is expected to slow the pace of tightening. After that, three or four more hikes are priced in, but all quarter-point, and policymakers are seen around the 3% mark.

That’s far less than what’s currently considered a high ‘shrinking’ rate — meaning there’s no need to orchestrate a sharp slowdown to curb price pressures or restore central bank credibility.

What Bloomberg Intelligence says…

“We believe that risks tilt upwards. The Bank of Canada is likely to revise inflation forecasts even higher in July. If price pressures continue into the third quarter, it may be difficult for the central bank to pause in 2H, but a cut to 25 bps is certainly possible.”

–Angelo Manolatos, senior associate analyst, and Ira Jersey, chief US interest rate strategist

For the full analysis, click here

There is also nothing alarming in the data to suggest that the central bank is too late to bring about a soft landing. Average wage growth has risen to just over 3%. That’s still well below inflation, which stood at 6.8% in April, and not too far above what would be considered normal in non-crisis times anyway.

According to monthly surveys by the Canadian Federation of Independent Business, the pace at which companies expect to push prices up has also fallen in recent months, a reassuring sign.

But as Macklem joked in a speech ten years ago, credibility is hard to earn, but easy to lose. That is why the central bank is not taking any risk and is reducing interest rates to neutral as soon as possible. The current policy rate remains very stimulative.

After all, it has become clear – at least in retrospect – that the Bank of Canada has injected more stimulus into the economy than it needs to, and has been too late to pull out. While it is difficult to blame Macklem for much of Canada’s current inflation, which is being driven by global factors, policymakers know they are fueling price pressures and fueling a housing bubble.

The rapid course correction comes because officials want to avoid any perception that they have become more tolerant of inflation.

Macklem’s recent admission that some mistakes have been made in response to the Covid-19 crisis was part of that. The mea culpa has one purpose: to reassure Canadians that the price hike was not necessarily intended.

In any case, the political attacks will accelerate what will likely be years of postmortem for Canada’s stimulus efforts during the pandemic — for both the Bank of Canada and Prime Minister Justin Trudeau.

That’s okay, and the central bank seems open to the debate.

“Tough questions, extra scrutiny and informed debate are perfectly appropriate in today’s environment,” said senior vice governor Carolyn. Rogers said in a speech this month.

That postmortem will likely include whether the central bank has strayed too far from its core mandate, a discussion many economists will welcome.

There is an erosion of trust between the central bank and conservatives that predates the pandemic and that is an untenable situation for an institution whose effectiveness depends on credibility.

Most recently, Pierre Poilievre, the frontrunner to win the Tory leadership, announced that he would fire Macklem if he ever come to power, which is a possibility.

While most dismiss the 42-year-old lawmaker’s rhetoric as a bluff, it’s also not hard to see concerns that the central bank had lost focus on inflation and may have been too accommodating with politics. It’s also a debate that’s going on in other countries as well, including increasing scrutiny at the Bank of England and the Federal Reserve.

In Canada, look no further than the central bank’s renewal of its inflation target mandate last year, which seemed uncomfortably political to many. Ragan and other economists complained that the introduction of language about maximum employment and climate change appeared to have been written by the office of Treasury Secretary Chrystia Freeland and not by officials of the Bank of Canada.

“The answer is to reduce inflation,” William Robson, chief executive officer of the CD Howe Institute in Toronto, said by phone. “If inflation remains high, this problem will not go away, no matter what we think of Pierre Poilievre.”

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