Like many other observers, McMahon is expecting the Bank of Canada to announce a 0.75% rate hike in July. Even barring the unexpectedly strong 7.7% inflation print announced last Wednesday, he says both the BoC and the Federal Reserve need to bring monetary policy to the neutral rate as quickly as possible. For Canada’s central bank, the neutral rate is between 2% and 3%.
“Recently, the BoC’s Deputy Governor Phillip Beaudry flagged that they want to go to the high end of neutral. So I think if you’re the bank, it will be key to get there quickly in 75-basis point increments, which means getting to 3% by early September.”
Even if the central bank were to reach its terminal policy rate of 3%, McMahon says, the odds are inflation will still be elevated above recent history, but at a more modest 3% to 4% annual rate as of late 2023 or 2024. Aside from the demand-driven component of inflation, which the Bank of Canada can address through its monetary policy, prices are escalating from factors that are more supply-driven.
He notes that the Russia-Ukraine conflict has exerted an obvious impact on both energy and food prices. Droughts around the world, including North and South America, are also putting pressure on the global food supply, he adds, and gasoline prices are soaring due to COVID impacting the operating capacity of refineries.
“Of course, it would be a good thing if we had a resolution to the Russia-Ukraine conflict. But I think the damage is done,” McMahon says. “It’s already taboo to do business with Russia; Europe, its biggest customer, is actively working on not relying on Russia anymore. And Ukraine is a large grain producer, so even if the war were to end today, the lingering effects would likely last for multiple quarters and even years.”
