Are We There Yet?

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Avery Shenfeld

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Text transcript

Avery Shenfeld, chief economist at CIBC.

Many people we talk to want to know, ‘are we there yet’ in terms of the process of the Bank of Canada raising interest rates?

We do think that we’re getting closer to the destination, but we do see the Bank of Canada raising interest rates another half a percent this month. And hopefully, starting to see some signs that the economy is beginning to respond to the rate hikes they’ve already put into place so that, by December, they’re able to say, “We’re going to put a hold on further rate hikes for now. See how it goes.” And our expectation is that with the overnight rate of interest then not far from 4%, that they’ll be able to pause right through 2023.

Now, the Federal Reserve and other central banks are also pressing ahead with higher interest rates. Note that it’s not a case of monkey see, monkey do. The Bank of Canada has historically moved in the same general direction as the Fed, but there are reasons to suspect that the US Central Bank may take rates south of the border a bit higher than we’ll have to here. Remember that Canadians are facing the rollover of a lot of mortgage debt. So far, only about a quarter of all household debt has been renewed at higher interest rates. But the Bank of Canada is well aware that over the next couple of years, many Canadians will see a substantial increase in their monthly payments. And so, the full impact of interest rate hikes on household spending power in Canada won’t really be rolling out until well into 2023 and even 2024.

In contrast, in the US, Americans have fixed 30-year mortgages that don’t come due for renewal at any time, and therefore, Americans are less affected by this process of higher interest rates, which is why we see the Federal Reserve taking rates to four and a quarter or even four and a half, whereas the Bank of Canada could well stop at three and three quarters or perhaps 4%.

That’s not going to mean, though, that the two economies both see a substantial slowing. Our estimate is that both economies need a roughly flat period with almost no economic growth through the first half of 2023 if we’re going to bring inflation back down to 2%. And we’re going to need to keep interest rates at these levels, really, right through 2023 and perhaps into 2024 before there is room to start lowering them again to allow for a pickup in economic growth.

So, while a soft landing is still somewhat in doubt, we’re hopeful that we don’t see an outright recession, but only a period of essentially zero growth for a couple of quarters. 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 to 2%.

The risks that we get spilled into an outright recession seem higher in Europe, where they’re dealing, not only with inflation and rising interest rates, but the fallout from the war in Ukraine and its impact on natural gas supplies, and therefore, energy prices to Western Europe. A recession in Europe will help slow global inflation, and to some extent, reduce the need for the Bank of Canada to be as aggressive as it might otherwise have to be. But we are going to see a period where the global economy, and therefore, financial markets that depend on the global economy, facing a tough period for earnings growth.

Remember that many of the companies that are based in Canada sell products at world prices or on global markets. And so, a recession in Europe and the UK, a slow pace for China, and of course, a brush with something close to recession in the US will have an impact for Canadian corporate earnings in the next couple of years. So a soft landing perhaps for the economy, but still a bit of a bumpy road for financial markets.