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Posthaste: Why one of Tiff Macklem's biggest critics is worried he won't hike rates high enough

Financial Post logo Financial Post 2022-11-24 Gigi Suhanic
Bank of Canada governor Tiff Macklem acknowledged the central bank was slow to start hiking interest rates. © Provided by Financial Post Bank of Canada governor Tiff Macklem acknowledged the central bank was slow to start hiking interest rates.
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Good morning!

Bank of Nova Scotia economist Derek Holt is one the Bank of Canada’s loudest critics on Bay Street. Holt bayed angrily when governor Tiff Macklem opted against raising interest rates in January, rightly so in retrospect, as Macklem later conceded that he probably should have moved against inflation sooner.

Macklem insists that he learned from his mistake, but Holt is unconvinced. While some economists, politicians and union leaders are concerned Macklem is raising interest rates too quickly, Holt says he’s worried the Bank of Canada won’t hike high enough.

“A tight economy generating wage gains above the growth rate in productivity alongside an undervalued currency is courting a protracted challenge to the Bank of Canada’s inflation target that probably slants the risks more toward under-tightening than over-tightening,” Derek Holt, head of economics at the Bank of Nova Scotia, said in an investor note  this week.

In an attempt to push down inflation, the Bank of Canada has lifted its benchmark interest rate six straight times since March to 3.75 per cent from 0.25 per cent. Another increase of 25 to 50 basis points is expected at its next meeting on Dec. 7.

Macklem acknowledged the delicate dance the Bank of Canada is currently engaged in with rates and inflation during testimony to the House finance committee on Wednesday evening.

“We are trying to balance the risks of under- and over-tightening,” Macklem said in prepared remarks . “If we don’t do enough, Canadians will continue to endure the hardship of high inflation. And they will come to expect persistently high inflation, which will require much higher interest rates and, potentially, a severe recession to control inflation. Nobody wants that.”

There are a few reasons Holt is worried that the central bank risks undershooting on interest rates, and, by association, inflation.

Primarily, the economist said there is still too much demand in the Canadian economy, something Macklem also touched on in his remarks. As evidence, Holt cited gross domestic product (GDP) numbers that have held up better than expected during the central bank’s rate hikes.

In the second quarter, the economy posted GDP growth of 4.2 per cent quarter over quarter on a seasonally adjusted annualized rate. For the third quarter, Holt said he is forecasting growth of about 1.5 per cent, and “Q4 is running at a similar pace on an extremely tentative basis since obviously we don’t have much Q4 data.”

Holt said these numbers hint that “the economy is not yet opening up any disinflationary slack — (supply outstrips demand) which requires a protracted period of actual GDP growth below the economy’s potential GDP growth.”

Another concern of Holt’s is the Bank of Canada’s theory that wage growth is peaking .

Wages grew 5.6 per cent in October compared with a year ago, according to Statistics Canada. It was the fifth month in a row that the average hourly wage has risen more than five per cent.

Relief on that front could be hard to come by as union leaders in Canada continue to agitate for pay increases despite Macklem cautioning that baking in higher wages to offset inflation could lead to a pay/price spiral where one begets the other.

Furthermore, the jobs market is “incredibly strong,” Holt said. The unemployment rate currently stands at 5.2 per cent, just off June’s record low of 4.8 per cent. The economy in October generated 108,000 new net positions with Statistics Canada reporting that the participation rate had risen last month.

Another data point that causes Holt pause is the drop in Canada’s labour productivity rate, which measures the amount of goods a workforce produces in a given amount of time. Since the start of the pandemic, Statistics Canada’s labour productivity index has fallen to a reading of 158.7 in the second quarter of 2022 from 187.67 in the second quarter 2020 . But productivity is still outpacing compensation when wages are adjusted for inflation, according to the index.

“The point … is that Canada needs to open up a lot of slack in the economy in order to cool inflationary pressures that have both demand-side and supply-side drivers and both of these sets of drivers should be targeted by monetary policy in order to align the two over time,” Holt said.

Holt is an outlier, maybe even in his own shop, as the Scotiabank economics team predicts the Bank of Canada’s benchmark rate will rise to 4.25 per cent, which appears to be where Macklem is headed. But Holt was right once. Maybe he’ll be right again.


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Today’s Posthaste was written by Gigi Suhanic (@gsuhanic), with additional reporting from The Canadian Press, Thomson Reuters and Bloomberg.

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