The Bank of Canada removed any lingering doubts last week about its commitment to fighting inflation.
It delivered a jumbo rate hike of 100 basis points — or a full per cent — while facing an annualized inflation rate of more than seven per cent, according to the most recent figures from Statistics Canada.
South of the border that rate is even higher, said to be 9.1 per cent according to the latest figures. That’s important to us because the Bank of Canada almost always, out of necessity, tracks the U.S. Federal Reserve’s interest rate moves.
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Ignoring the U.S. rates and allowing them to get out of sync would cause the loonie to either rise (when their rates are lower) or fall (when their rates are higher) to damaging levels.
If too low, imported goods — such as equipment — become unaffordable. Too high and exports — including grain and oil — become less profitable to domestic producers.
That’s why expectations for further rate hikes this year from the U.S. Fed have to be taken seriously on this side of the border. The numbers are impressive. In mid-June, after its last hike, the Fed was suggesting interest rates could end up around 3.4 per cent by year’s end, or nearly double the current rate of 1.5 to 1.75 per cent.
Already mortgage markets on both sides of the border are pricing these moves into their retail interest rates. The average long-term U.S. mortgage now sits at 5.51 per cent, and the Canadian rates are just below five per cent for a five-year mortgage.
Whether this trend continues upward in the coming months and years depends on several factors, none of which are clear.
Will inflation continue to heat up or will some of the measures take the fire out of it? Most economic theorists would say that, to have an effect on inflation, interest rates need to be at a higher rate than the inflation itself.
They’re not there yet, and so far, policy makers appear to be hoping interest rates and inflation will meet somewhere in the middle.
They’re pinning this hope on the notion that much of the inflation we’re seeing is a result of supply constraints rather than increased demand. The broad view is that COVID-related supply chain snarling has led to the current situation, exacerbated by the war in Ukraine. As these situations resolve, the hope goes, so too will inflationary pressures begin to dissipate.
There’s some positive news. The U.S. data suggests some of the underlying inflationary pressure in its producer price index is easing. Oil prices have fallen to below US$100 a barrel, after being as high as $139 in March.
Other commodity prices have also fallen, unfortunately including agricultural commodities. While that may be a bitter pill for farmers in the short term, in the longer term, easing inflation and keeping interest rates on the lower side may be better for their economic health.
However, that’s not to say the fight is won. There’s also a very important psychological component to any economic question, and here the news isn’t quite so cheery.
It seems people have come to believe inflation will continue. Two recent reports from the Bank of Canada paint a grim picture.
In its business outlook survey, released in early July, it reported that most businesses now expect inflation to be higher and more prolonged than they previously thought. Businesses were most concerned with labour shortages, expected wage growth and supply chain bottlenecks, the report said.
On the consumer side, the snapshot is just as dark. The Bank of Canada found consumer expectations for inflation have also risen. Most are worried about rising prices for food, gas and rent. The report also said the expectation of higher inflation and interest rates is affecting consumer confidence.
I recently talked about interest rates with J.P. Gervais, chief agricultural economist for Farm Credit Canada, the country’s largest agricultural lender, for Glacier FarmMedia’s Between the Rows podcast.
He confirmed that producers need to seriously consider rising interest rates, but added that a measured and systemic approach is best. His first suggestion was to engage in some old-fashioned business math. Figure out your net income and debt obligations, and use those figures to work out how much room your farm has to absorb higher rates.
He also suggested that now is the time to be a CEO for your farm. A CEO, he explained, doesn’t know it all, but he or she knows enough to ask the right questions of the right people, such as a lender, accountant or other expert.
“Surround yourself with the right people” is sound advice in any times.
