BMO economist dissects heightened inflation pressures behind call for more aggressive rate increases
Following recent economic events and high-profile data releases, many financial analysts were compelled to re-evaluate their initial Fed and Bank of Canada policy forecasts. Among them was BMO, which is expecting Canada’s central bank to take on more rate hikes than it initially thought.
"Given our call for a more aggressive rate hike path in the U.S., and the strong inflation and housing data, we’re now calling for one additional BoC hike in 2022, bringing the total tightening to 150 bps by year-end,” said BMO economist Benjamin Reitzes in a recent note.
The Big Six bank, according to Reitzes, expects the BoC to raise rates by 25 basis points in each of its next five sessions before taking a break in December. It’s projecting one final 25-basis-point boost in January, bringing policy rates to 2%, where they are expected to climax.
Reitzes pointed to the recent February CPI report, which came in at a 31-year high of 5.7% year over year. That brought the quarter-to-date average to 5.4%, and it's expected to rise much higher next month.
Inflation in March is expected to come in at the 6% range, he noted. But given current commodity costs, Reitzes said that it is unlikely to surpass the 6.9% high set in 1991, though he stopped short of ruling it out.
“Inflation has consistently surprised on the high side over the past few quarters, and there’s no sign that the fever is going to break near-term,” he said. While drastic moves in energy prices since Russia's invasion of Ukraine are proving to be a huge wild card for the inflation picture, he maintains that risks on that front appear to be weighted toward the upside.
Food prices are following a similar pattern, with the fastest increases in 31 years in the last four months. The crisis in Ukraine is also posing a significant threat to prices of wheat and other grain products. In the meantime, milk costs soared in February, as did the prices of a variety of other foods.
“The sheer breadth of items seeing big price increases is what is truly concerning,” Reitzes said.
A breakdown of the CPI basket shows that out of 41 major categories, 37% are up by 6% or more, representing the most significant broadening of inflation since 1991. All three core measures of inflation have been moving consistently higher, he said.
The most important message was that the housing market is still “ridiculously strong,” he said, pointing to record highs in the monthly and yearly gains of the MLS HPI and the parabolic trajectory of prices in a number of cities.
“We warned almost exactly a year ago that the housing market threatened to get out of hand if no policy actions were taken, and here we are,” he said.
Despite the numerous headlines about a shortage of supply, he said the extraordinary price increases are mostly attributable to rock-bottom interest rates and prospects of future gains boosting demand.
“Higher interest rates are needed to bring some sanity to the market, and those rate hikes clearly can’t come soon enough,” he said.
