MNI INTERVIEW: BOC 'Straddling Both Sides' In Rate Hold-Stillo

Bank of Canada Governor Tiff Macklem remains on track to leave interest rates unchanged this year and equally prepared to hike or cut if the Iran war or tougher U.S. tariffs throw the economy off course, a former official from the country's largest province told MNI.

“Macklem appropriately said this is a dilemma for a central bank because you've got the weakness in the economy and at the same time higher prices,” said Tony Stillo, former forecasting manager at Ontario’s finance ministry and now Canada Director at Oxford Economics. The Bank held its key rate at 2.25% Wednesday and said the range of outcomes has widened while dropping earlier language about holding rates.

“The Bank is ready to move in either direction. They are firmly on the fence, straddling both sides of it,” he said, adding those moves might be in the order of 50bps in either direction if it becomes clear a change is needed. 

The Bank historically looked through jumps in energy prices but this time there is more concern about being caught the way some officials were by sticky post-pandemic inflation, Stillo said. Export and job market weakness could pull the economy the other way if Donald Trump takes further action against Canada. But with borrowing costs near neutral, there's less reason for the big swings in rates seen through Covid, Stillo said. (See: MNI INTERVIEW:Canada Exports Resilient Amid US-Iran Strife:EDC)

“It would have to be a lot more negative for them to go and ease," Stillo said. "Even then they would ease modestly, they wouldn't go to pandemic lows.” In that period the rate fell to 0.25% and was boosted up to 5% as inflation moved to 8%. 

BOND MARKET WORRIES

On trade there are several plausible situations where the U.S. makes things more difficult without completely breaking up with Canada, he said. The Middle East conflict could wind down and after a period of readjustment supply chains normalize, Stillo said. Inflation will likely quicken beyond 3% in Canada for a while because of higher energy costs but that will only "test" the Bank's resolve to hold, he said.

If the Bank sees “that inflation expectations are moving up, they'll lean against that,” he said. “Some observers say there's a dovish bias,” he said, “but I think that they're equally likely to raise rates if need be.” (See: MNI INTERVIEW: BOC Rate Hike Odds Rise With Higher Oil- ATB)

Fiscal policy is helping stabilize the economy this year with ongoing deficit spending, a new grocery tax credit and Canada's boost to short-term oil production, Stillo said. Officials understand "the monetary policy tool is not the most effective tool to deal with supply shocks or structural change,” he said. 

Canada's deficits and global worries around inflation and risk premiums are why the country's government bond yields have climbed lately, more than because a view the Bank will jack up borrowing costs, Stillo said. Canada's two-year bond yielded 2.89% Thursday afternoon, up from 2.39% at the end of February. 

“That's the risk premium, the inflation risk, also the risk on the fiscal side, not just in Canada, but in the U.S. as well. And in Canada, when we think of all these wonderful things that we want to do here, they're still largely deficit financed," he said. "The trend we see for bond yields in Canada is to rise over the next few years.”