Analysis: Bank of Canada uses ‘shock and awe’ to bolster inflation fight credibility

Bank of Canada Governor Tiff Macklem attends a news conference in Ottawa, Ontario, Canada, April 13, 2022. REUTERS/Blair Gable/File Photo

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  • Inflation soared to 7.7% in May, its highest level since the start of 1983
  • The central bank has clearly signaled 2 previous hikes of 50 basis points
  • Governor says credibility of inflation target is being tested

OTTAWA, July 14 (Reuters) – The Bank of Canada unveiled a “shock and appalling” interest rate hike of one percentage point on Wednesday, a surprise move that marked a change of message for a central bank desperate to show it can tame the worst inflation since 1983, analysts say.

Two previous rate hikes of 50 basis points in April and June were clearly signaled by Governor Tiff Macklem. But the head of the Bank of Canada has spoken publicly only once since last month’s hike, saying the central bank was ready to act “more forcefully”, which was interpreted as paving the way. up 75 basis points.

After that, he remained silent.

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“Overshooting the forward guidance might have been the goal – by offering more than expected, policymakers might have hoped to amplify the psychological impact on businesses and consumers,” said Karl Schamotta, chief market strategist at Corpay. , a business payment company.

“It’s a ‘shock and awe’ strategy,” he added.

Markets took notice, sending the Canadian dollar higher against its U.S. counterpart, while driving the main Canadian stock index (.GSPTSE) down to its lowest close since March 2021.

Macklem, who took office as governor amid the pandemic, has come under rare political attack for failing to get inflation under control, which jumped to 7.7% on an annual basis in May, the highest rate since January 1983. read more

As inflation began to spiral out of control earlier this year, senior Bank of Canada officials admitted to making “mistakes” and the central bank said on Wednesday it was consistently underestimating inflation, mainly in due to global shocks. Read more

In an interview with the Financial Post newspaper published Thursday, Macklem said the central bank likely would have raised interest rates sooner if it had known everything it knows now a year ago. Read more

‘LARGE RESET BUTTON’

Canada became the first G7 country to take a 100 basis point rate hike in this economic cycle, and Macklem broke with what had been its rigid approach to messaging.

In July 2020, the Bank of Canada promised to hold interest rates at rock bottom until “the economic downturn subsided”, which was expected to take years, and sticking to it meant that its The first rate hike came in March when inflation was already well above the central bank’s target range of 2-3%.

“The Bank realizes that failing to meet its 2% inflation mandate hurts its credibility much more than deviating from vague forecasts,” said Jay Zhao-Murray, market analyst at Monex Canada. , a financial services company.

Zhao-Murray added that the surprise 100 basis point hike is likely to add to Canadians’ economic anxiety, but ultimately it should also lead to lower inflation expectations, a cycle of rising less restrictive rate and reduced pricing pressures.

In comments after Wednesday’s rate hike, Macklem noted that the credibility of the central bank’s 2% inflation target “is being tested”, citing recent business and consumer surveys. which showed that inflation is expected to persist.

But analysts, while acknowledging it’s a good move, said the Bank of Canada’s change in approach comes at a cost.

The central bank is set to “provide less guidance,” said Greg Anderson, global head of currency strategy at BMO Capital Markets in New York.

“And presumably less guidance means less certainty, means wider risk spreads and more risk premia for financial assets.”

Derek Holt, vice president and head of financial markets economics at Scotiabank, said the Bank of Canada had caused “economic anxiety among households and businesses because they had blinders on. against any whiff of inflation risk as it unfolded in real time last year.”

The full percentage point jump shows “they just realized they messed up” and “is an acknowledgment that they had to hit a big reset button on what they were doing,” Holt said.

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Reporting by Steve Scherer and Fergal Smith; Editing by Paul Simao

Our standards: The Thomson Reuters Trust Principles.

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