“Why is the current tightening cycle different from anything we’ve seen in the past?”
By Wolf Richter by WOLF STREET.
When Canada’s consumer price index for May was released a couple of days ago, it was, “as expected”, I would say, much worse than expected, once again beating the inflation forecasts for the Bank of Canada. . According to the exasperated economists of the National Bank of Canada, CPI inflation is 1.5 percentage points above the BoC’s CPI forecasts, beating those forecasts every step of the way. May was “the biggest mistake yet in what has been a systematic underestimation of inflation,” they wrote in a note.
“So if the May CPI report doesn’t set off alarm bells in the Governing Council [of the Bank of Canada]someone should take their collective pulse”, they pointed out.
Canada’s headline CPI rose 7.7% in May compared to a year ago, the worst rate of inflation since 1983, according to Statistics Canada:
The BoC has already raised its official interest rates by 125 basis points to 1.50%. At its last meeting, it included aggressive language of more and larger-than-expected hikes, such as a 75 basis point hike at the July meeting. The BoC has also embarked on QT, and its balance sheet has been shrinking since March 2021. But the rate hikes and aggressive language of future rate hikes were based on the BoC’s inflation forecasts, which have been “a systematic underestimation of inflation”. So this rate hike cycle is going to get interesting.
Month on month, the CPI jumped an impressive 1.4% in May from April, without seasonal adjustment; and 1.1% seasonally adjusted. Unsurprisingly, I’d say those spikes completely blew away expectations.
Month-on-month CPI rates for March, April and May, annualized, soared to an annual rate of 12.5%.
The sizzling month-over-month increases were across the board, and not just a few commodity-linked items. He gave the BoC more than enough reason to pull the trigger on a 75 basis point hike at their July 13 meeting.
“Inflation forecasts are not worth the paper they are written on.”
The BoC’s inflation forecasts it released at each of its previous meetings since April 2021 are shown in different colors in the chart below from the National Bank of Canada’s Financial Markets store. The red line is the current CPI rate for each quarter. The BoC estimates start at each meeting with the current CPI rate at that time.
So, at its April 2021 meeting (light blue, first line from the bottom), as inflation had started to rise, the BoC estimated that the CPI would peak at just under 3% in mid-2021 and then decline at 2% by March 2022. hahahaha
Then at their July 2021 meeting, the BoC forecast that inflation would peak at 3.8% by the third quarter of 2021, then drop to 3% about now lol, and 2% by the third trimester.
The chart above shows how ridiculously far off these inflation forecasts were, and how this inflation is a huge wild card that continues to get worse, even as commodity prices have started to decline.
“For BoC watchers trying to compare today’s inflation path to previous episodes of monetary tightening, desist. There is simply no comparison in the era of overnight interest rate targeting (which began in the mid-1990s). That is why the current tightening cycle is unlike anything we have seen in the past,” Warren Lovely and Taylor Schleich of the National Bank of Canada said in their note.
“As aggressive as the last two BoC actions may have seemed at the time, it’s time to tighten the screws even more,” they said.
“A 75bp rate hike on July 13 won’t fix Canada’s inflation problem, not with labor markets as tight as they are. In addition, the job vacancy data is clearly worrying, and Canada’s acute labor shortage will not be quickly remedied despite a resumption of healthy population growth. [through immigration]”They wrote.
And they added, sprinkled with a stark and inflationary humor:
“To summarize: we have runaway inflation. Simply sending more money to households as some governments have done (or intend to do) is like adding (already expensive) gasoline to the fire.
“Inflation calls for a super forceful BoC reaction, including a 75bp hike in three weeks’ time.
“One-off rate hikes have done little to control prices (so far), but have turned property markets upside down. The psyche of consumers is hanging and the risks of recession have increased.
“Indeed, with inflation data like this, ensuring a ‘soft landing’ could be like threading the eye of a needle. We haven’t completely given up hope, but today’s CPI report should clear even the most enthusiastic among us.”
The Fed was also ridiculously wrong with its inflation forecast every step of the way and has now been burned at the stake for its use of “temporary” and transient. The ECB has also been ridiculously far off with its inflation forecasts. Monetary policies, their refusal to raise rates from early 2021 and their refusal to end QE and start QT at the same time, were driven by this ridiculous underestimation of inflation, but now they have received the memo.
It is an interesting turn of events that economists at the big banks in Canada, as well as in the US and elsewhere are urging their respective central banks to crack down on inflation by increasing rates ever higher, as that this inflation threatens to spiral out of control. After which, the economic and financial damage from rampant inflation will be enormous.
Stock and bond markets have already reacted sharply to this tightening scenario, and in Canada, housing markets have already “rolled over”, and central banks have just started to tighten, and nothing the banks did plants in recent decades can be compared with what is to come. below, and if a recession is part of the deal to rein in runaway inflation, so be it.
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