“Why the current tightening cycle is unlike anything we’ve seen in the past.”
By Wolf Richter for WOLF STREET.
When the Consumer Price Index for Canada for the month of May was released a few days ago, it was – “as expected”, I would say – much worse than expected and once again far exceeded forecasts Bank of Canada inflation rate. . According to exasperated economists at the National Bank of Canada, CPI inflation is 1.5 percentage points ahead of the BoC’s CPI forecast, beating those forecasts every step of the way. May was “the biggest miss yet in what has been a systematic understatement of inflation,” they wrote in a note.
“So if the May CPI report doesn’t set off alarm bells at the Governing Council [of the Bank of Canada]someone should check their collective pulse,” they noted.
The headline CPI for Canada jumped 7.7% in May from a year ago, the worst inflation rate since 1983, according to Statistics Canada:
The BoC has already raised its key rates by 125 basis points, to 1.50%. At its last meeting, it included hawkish language of more and bigger hikes than expected, such as a 75 basis point hike at the July meeting. The BoC also embarked on the QT, and its balance sheet has been shrinking since March 2021. But the rate hikes and hawkish language of future rate hikes were based on the BoC’s inflation forecast which has been “a systematic underestimation of inflation”. So this rate hike cycle is going to get interesting.
On a month-to-month basis, the CPI jumped 1.4% in May compared to April, not seasonally adjusted; and 1.1% seasonally adjusted. As expected, I would say, these spikes totally swept away expectations.
The monthly CPI rates for March, April and May, annualized, reached an annual rate of 12.5%.
The meteoric month-over-month increases were widespread, and not just in a few commodity-related items. That gave the Bank of Canada more than enough reason to pull the trigger on a 75 basis point hike at its July 13 meeting.
“Inflation forecasts aren’t worth the paper they’re written on.”
The Bank of Canada’s inflation forecasts that it has published at each of its previous meetings since April 2021 are represented in different colors in the chart below from the National Bank of Canada’s Financial Markets Shop. The red line is the actual CPI rate for each quarter. Bank of Canada estimates begin at each meeting with the CPI rate then in effect.
So, at its April 2021 meeting (light blue, first row from bottom), as inflation had begun to soar, the Bank of Canada estimated that the CPI would peak at just under 3% by mid-2021, then decrease to 2% by March 2022, hahahaha.
Then at its July 2021 meeting the Bank of Canada projected that inflation would peak at 3.8% by the third quarter of 2021 and then drop to 3% around that time, hahahaha, and at 2% by the third quarter.
The chart above shows how ridiculously far off those inflation forecasts were and how that inflation is a big wild card that keeps getting worse, even as commodity prices have started to fall.
“For Bank of Canada watchers trying to compare the current path of inflation with previous episodes of monetary tightening, give up. There is simply no comparison to the era of the target overnight rate (which began in the mid-1990s). That’s why the current tightening cycle is unlike anything we’ve seen in the past,” National Bank of Canada’s Warren Lovely and Taylor Schleich said in their note.
“As aggressive as BoC’s last two actions may have seemed at the time, it’s time to tighten the screws even more,” they said.
“A 75 basis point rate hike on July 13 will not solve Canada’s inflation problem, not with labor markets as tight as they are. Incidentally, the job vacancy data is clearly concerning, and Canada’s severe labor shortage will not be rectified soon despite a resumption of healthy population growth. [through immigration],” they wrote.
And they added – sprinkled with bloated humor:
“To sum up: we have inflation out of control. Simply sending more money to households as some governments have done (or intend to do) is like adding gasoline (itself already expensive) to the fire.
“Inflation demands an extremely aggressive response from the Bank of Canada, including a 75 basis point hike in three weeks.
“The one-off rate hikes have done little to control prices (so far), but have shaken up housing markets. Consumer psyches are one to watch and recession risks have increased.
“Indeed, with inflation data like this, ensuring a ‘soft landing’ could be like threading the eye of a needle. We haven’t totally given up hope, but today’s CPI report’ today should sober even the most enthusiastic among us.
The Fed was also ridiculously off track with its inflation forecasts every step of the way and has now been burned at the stake for its use of “temporary” and transitory. The ECB too has been ridiculously off track with its inflation forecasts. And their monetary policies – their refusal to raise rates from early 2021, and their refusal to end QE and start QT at the same time – were driven by this ridiculous understatement of inflation. they got the memo.
It’s an interesting turn of events that big bank economists in Canada as well as the United States and everywhere else are urging their respective central banks to quell inflation by raising rates ever higher as inflation threatens spin out of control, after which the economic and financial damage from runaway inflation will be enormous.
Equity and bond markets have already reacted strongly to this tightening scenario, and in Canada, housing markets have already “whirled” and central banks have only just begun to tighten, and nothing banks power plants have done over the past few decades can only be compared to what comes next, and if a recession is part of the market to bring this runaway inflation under control, so be it.
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