Are we there yet?

Despite central banks’ best efforts, inflation is still too high for anyone’s liking.

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And while there have been some early signs of a slowing economy, Avery Shenfeld, ​​CIBC’s chief economist, said more interest rate hikes will be necessary to bring inflation down.

Earlier this week, Bank of Canada governor Tiff Macklem conveyed a similar message. He said the core measures of inflation “have yet to decline meaningfully” even as headline inflation has come down.

Shenfeld predicts the central bank will raise interest rates another half a percent this month. Ideally, he said, by the end of the year the economy will have started responding to the rate hikes already in place, and the central bank will be able to put a hold on further hikes through 2023.  

The Bank of Canada makes its next interest rate announcement on Oct. 26.

South of the border, the Federal Reserve is pressing ahead with its own aggressive tightening. And while the Bank of Canada has historically followed suit, Shenfeld said he doesn’t think Canadian rates will go as high as in the U.S.  “It’s not a case of monkey see, monkey do,” Shenfeld said. 

In Canada, only about one-quarter of all household debt has been renewed at higher interest rates, but the impact of interest rate hikes on household spending power will be seen in 2023 and into 2024, he said.

In contrast, Americans have fixed 30-year mortgages and are therefore less affected by higher rates, which gives the Fed more room.

Shenfeld said while the Fed could raise rates as high as 4.25% or even 4.5%, the Bank of Canada likely won’t go higher than 4%. 

But that doesn’t mean there needs to be a substantial economic slowdown. To bring inflation back to its 2% target, Shenfeld said growth will need to remain flat in both the U.S. and Canada through the first half of 2023. Interest rates will also need to remain at their current levels throughout 2023 and possibly even into 2024 before central banks can start lowering them again. 

So while a soft landing is doubtful, Shenfeld said an outright recession can still be avoided.

“If we don’t see a big recession in 2023, we’re likely going to have to see a period of sluggish growth for a bit more than a year in order to cool the labour market enough to get inflation back down,” he said. 

However, the risk of a recession in Europe is much higher, Shenfeld said. On top of inflation and rising interest rates, the European economy is still dealing with the fallout from the war in Ukraine and its impact on natural gas supplies. 

The good news is that a recession in Europe would help slow global inflation, and therefore reduce the need for the Bank of Canada to be as aggressive as it might otherwise have to be. Either way, Shenfeld said that even if the economy achieves a soft landing, it will still be a “bumpy road” for financial markets.

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