Bank's assessment of increased inflationary risks at odds with forecasts of economic weakness, Capital Economics says
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The Bank of Canada keeps saying another interest rate hike may be needed to wrestle down inflation, but Canadians may not have to worry about that actually happening if the bank’s own economic forecasts pan out, a new assessment from Capital Economics says.
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Policymakers at the Bank of Canada held the key policy rate at five per cent last week, but cautioned they may need to raise interest rates again thanks to an increase in inflationary risks. As a result, the central bank expects inflation to stay above its two per cent target until 2025. But economists at Capital Economics say the bank’s projections don’t actually support that view.
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“The Bank of Canada’s insistence that inflationary risks have increased seem at odds with its new forecasts, which show a large degree of economic slack coming up next year,” Stephen Brown, said in a note on Oct. 27.
Capital Economics said the central bank appears to be basing the increase in inflationary risks “solely” on a spike in oil prices, with WTI forecast to hit US$85 a barrel, according to the latest Monetary Policy Report. The bank said prices could rise further still if war in Gaza and Israel spreads.
But economists at Capital Economics say the central bank may be getting ahead of itself in its assessment of how much oil will actually impact inflation while also factoring in weak economic growth. “While we are in broad agreement about those external risks to oil prices, we judge that the bank is overstating domestic inflationary pressures,” Brown said.
The Bank of Canada forecasts inflation at 3.3 per cent this quarter and three per cent next year. But using those same oil price forecasts, Capital Economics expects inflation to fall to 3.1 per cent this quarter and fall further next year to an average of 2.5 per cent.
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The discrepancy could be explained by differing views over the path of home prices, which affects the rate of inflation. The Bank of Canada doesn’t explicitly forecast where it expects house prices to go next year, but based on statements in the Monetary Policy Report, it appears policymakers expect them to grow, Capital Economics said.
That’s evident in a chart in the Monetary Policy Report that projects shelter inflation will stay relatively flat over the next six months. In comparison, Capital Economics forecasts shelter inflation will start to ease in the beginning of 2024. That’s because the firm’s economists expect home prices to fall by five per cent in the first six months of the year, not rise, as the Bank of Canada appears to be assuming. Lower home prices are considered a downside risk to inflation, according to the bank’s own Monetary Policy Report.
But that’s not the only flaw in the Bank of Canada’s inflation forecast, Capital Economics said. Policymakers’ assumption that companies will keep raising prices, along with expectations that inflation will stay high, present another inconsistency. Capital Economics said those assessments don’t line up with the Bank of Canada’s downgrade of gross domestic product. The central bank now expects the economy to grow by only 1.2 per cent this year, 0.9 per cent in 2024 and 2.5 per cent in 2025. That suggests housing, consumer spending and business investment are all likely to be weak going forward.
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Slowing consumer demand will probably create the opposite effect on prices that the Bank of Canada is forecasting, Capital Economics said. As customer spending slackens, companies will make more competitive pricing decisions to win sales. Previously, strong demand had been the main driver of higher prices, which helped fuel inflation, they said.
Absent those higher consumer prices and entrenched inflation expectations, the Bank of Canada’s forecasts would therefore show inflation returning to two per cent in the last part of 2024 as GDP weakens, Capital Economics said.
Altogether, that means the Bank of Canada can drop language about raising interest rates sooner, rather than later.
“Our view that the bank is still overestimating the near-term outlook for both the economic growth and inflation suggest it won’t need to maintain its tightening bias for long,” Brown said.
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Prime Minister Justin Trudeau’s government is planning new measures to tighten standards on colleges, responding to criticism that Canada’s education sector is bringing in so many foreign students that it’s boosting pressure on housing and the labour market.
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Immigration Minister Marc Miller announced on Friday a framework that will push universities and colleges to set a higher standard for services, support and outcomes for international students, starting in time for the fall 2024 semester. Miller will also roll out measures to tackle admission fraud, according to a government statement.
The number of foreign students in Canada has tripled in about a decade, reaching more than 800,000 last year. International education contributes more than $22 billion to the Canadian economy annually — greater than Canada’s exports of auto parts, lumber or aircraft — and supports more than 200,000 jobs, according to Miller’s office.
Randy Thanthong-Knight, Bloomberg
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Today’s Posthaste was written by Victoria Wells, with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.
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2023-10-30 12:01:02Z
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