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Macklem speech - Sept. 2023
Photographer: David Kawai/Bloomberg via Getty Images

It’s possible interest rates aren’t high enough: BoC’s Macklem

While the Bank of Canada is “encouraged” by the way higher rates are working to slow inflation, Governor Tiff Macklem said it’s possible interest rates aren’t yet high enough.

“Monetary policy is working to bring inflation down—and we are encouraged by the progress we’ve made so far,” he told the Calgary Chamber of Commerce on Thursday, one day after the central bank opted to leave its policy rate on hold.

“But we are not there yet and we are concerned progress has slowed,” he added.

Macklem said that with consumer price index (CPI) inflation now at 3.3% as of July—down from a high of 8.1% in June 2022—the Bank’s 2% target is “now in sight.”

“Just as it took longer to see clearer evidence that higher interest rates were moderating demand in the economy, it may now be taking longer for this to translate into lower inflationary pressures,” Macklem explained.

“The other possibility, of course, is that monetary policy is not yet restrictive enough to restore price stability,” he added. “And unfortunately, the longer we wait, the harder it’s likely to be to reduce inflation.”

He noted that for future rate decisions, the Bank will be looking for further evidence that price pressures are easing.

Housing’s contribution to inflation

Macklem also acknowledged the fact that mortgage interest costs—which are up 30% compared to last year and directly a result of the Bank’s own interest rate hikes—are now the largest contributor to headline inflation.

Excluding mortgage interest costs, CPI inflation is running closer to 2.50%, which Macklem said has caused some to argue inflation is essentially back to its target.

“It’s true that if we hadn’t raised interest rates, mortgage costs might be lower today, but inflation throughout the economy would be a much bigger problem for everyone,” he said.

“To measure underlying inflation, we need a more systematic way of excluding components with big movements on both the upside and the downside,” he added. “Of course, if you take out only the things that are going up a lot, inflation looks lower.”

He said that’s the reason the Bank prefers core measures of inflation as a better barometer on underlying inflation, such as CPI-trim, which excludes mortgage interest costs. But even that measure of inflation is still at about 3.5% since it also excludes other prices that have dropped sharply over the past year.

And as he has done in previous speeches, Macklem acknowledged how difficult interest rate hikes have been on Canadians, but remained steadfast on the need to bring inflation back to the Bank’s 2% target.

“We know higher interest rates are hitting some Canadians hard, and we don’t want this to be any harder than necessary,” he said. “But letting too-high inflation persist would be worse. We are confident that 2% is the right target. The target is now in sight. We need to stay the course.”

Featured image: David Kawai/Bloomberg via Getty Images