April 26, 2022 | Posted by: Harold Hagen
Sentiment /ˈsen(t)əmənt/ a view of or attitude toward a situation or event; an opinion.
Seems inflation has turned into a runaway horse lately. From being largely under control for four decades, inflation began accelerating in the spring of 2020 around the world as economies unexpectedly rebounded from the brief but devastating coronavirus recession. The economic recovery, fuelled by huge infusions of government spending and super-low interest rates, caught businesses by surprise, forcing them to scramble to meet surging customer demand.
So how does consumer ‘sentiment’ play into this equation? The net effect of consumer expectations can have a much larger effect on economic outcome than standard economic theory would predict, becoming more important than actual inflation. When inflation expectations become unanchored in consumers’ minds, it becomes a self-fulfilling prophecy that drives the inflationary cycle.
When consumers and businesses believe that inflation will REMAIN high, they pull forward consumption to today (ie., businesses stock up on raw materials and other inputs, consumers spend on things today that they might otherwise save for). The sudden spike in consumption risks creating a self-reinforcing cycle whereby rising demand creates rising prices, which feeds back into expectations, and in turn creates more demand. Rinse, repeat.
The Bank of Canada recently reported in its Monetary Policy Report (APRIL 2022) that “the outlook for CPI inflation in Canada is higher than previously projected. Inflation is expected to average just below 6% through the first half of 2022 and remain well above the control range through the rest of the year.”
That said, The Bank of Canada does expect a steadily decline in inflation to “about 2.5% in the second half of 2023 and to the 2% target in 2024”. But no one can be certain, not even the Bank of Canada.
“Perception” of future inflation is everything. Any reversal in the current blistering rate of increase to inflation could have positive effects on the consumer perception that the government powers have some future ability to rein in inflation to its target 2% range. That is in part why the Bank of Canada raised its lending rate by 0.50% on March 02, and is hinting that another 0.5% increase could come as soon as June 01.
There is no disagreement that central banks are chasing inflation; the debate is over how fast they need to run to catch up. Many Canadian Banks are crying for aggressive action by the Bank of Canada to move swiftly until interest rates are above their neutral range of 2.5%. That would translate to a prime rate of approximately 4.95%, a full 1.75% higher than the current prime rate (Prime rate is currently 3.20% at time of this writing).
The Bank of Canada Govenor Tiff Macklem recently stated that he “will be considering” a second half-point increase when they next adjust the policy rate on June 1. Without a profound slowdown in the Canadian economy, you should expect the Bank of Canada to pursue the neutral rate, and pause to as inflation pressure adjustment.
Hang on. Life is going to be moving quickly for Variable rate holders.