TD Bank economists warn of challenges if Bank of Canada cuts rates amid high housing costs, emphasizing the need for clear communication. (BNN Bloomberg)
TD Bank economists are anticipating potential communication challenges for the Bank of Canada as it contemplates a reduction in interest rates this spring, especially with elevated housing costs. The Bank of Canada is widely expected to initiate a decrease in its benchmark interest rate this year, marking a shift from a series of rate hikes, with the possibility of cuts occurring as early as this spring.
In a report released on Wednesday, TD economists Beata Caranci and James Orlando pointed out that if the anticipated rate cuts materialize this spring, they would coincide with above-target inflation and persistently high shelter costs. This, the economists cautioned, could lead to confusion among the public and pose a significant "communication challenge" for the central bank. They emphasized the need for the Bank of Canada to adeptly convey that shelter costs do not singularly define broader inflation trends in the country. The economists argued that neglecting to do so might result in the central bank keeping rates elevated for an extended period, potentially hampering economic growth.
The report highlighted evidence suggesting a cooling of inflation in the Consumer Price Index (CPI), despite the notable inflation in mortgage-related expenses. According to Statistics Canada's latest report for November, the CPI increased by 3.1 percent on an annual basis, consistent with the previous month. Mortgage interest costs, surging by 29.8 percent year-over-year, played a pivotal role in driving the November CPI increase. Excluding these cost increments, the CPI would have been 2.2 percent, slightly above the Bank of Canada's two percent inflation target.
The economists at TD underscored the rise in the share of products in "deflationary territory" compared to pre-pandemic levels, along with an increase in the number of products experiencing inflation below three percent. Against this backdrop, the authors expressed concern that interest rate cuts, potentially driving demand and higher prices in the housing market, might complicate the Bank of Canada's efforts to "re-anchor consumer expectations."
The report pointed out that households often anchor their inflation expectations based on personal experiences, with a particular focus on monitoring home prices, almost as a national pastime in Canada. The economists noted that households tend to place disproportionate weight on expectations related to items experiencing more pronounced movements, such as housing. They highlighted that household expectations may have become even more sensitive to upward shifts in prices compared to the period before the pandemic when inflation was perceived as less dynamic.
