All other things being equal”, to use an expression dear to economists, the Bank of Canada will adopt the moderate scenario of increases in its key rate this year.
In the United States, the stronger than expected rise in inflation in January led several analysts this week to foresee a more “aggressive” Federal Reserve setting more aggressive interest rate hikes. On this side of the border, the so-called moderate scenario remains dominant, with four 25-point increases this year, pushing the Bank of Canada’s target for the overnight rate to 1.25%. Two additional increases would follow in 2023 to reach the so-called neutral rate of 2% between the end of next year and mid-2024. It should be noted that the Bank of Canada places the neutral rate in the middle of the 1.75-2.75% range. For its part, the more muscular scenario is based on six hikes in 2022, pushing the key rate to 1.75% in December, then to 2% somewhere in the first half of 2023.
All this being accompanied by the reduction in the size of the central bank’s balance sheet.
Oxford Economics does not believe in this latter trajectory. Such “dynamism” would be too harmful to economic recovery, says the analysis firm. The Bank of Canada will have to maneuver with caution, given the high level of household debt. Given, also, the overvaluation of residential real estate prices. Especially since the inflationary surge is global, fueled by soaring energy prices and distortions in supply chains, generating a supply shock against which the monetary authorities cannot much.
But it must fight the national part of the inflation stoked by the labor shortage and a tight labor market that could generate a wage-price spiral likely to unanchor inflationary expectations of the 2% target. “There is fear of real wages rising above trend productivity gains,” Oxford said.
On the real estate side, Oxford estimates that residential property prices were 15% above household borrowing capacity in the third quarter of 2023 (based on median income), and that this percentage is set to double this year. Also, at a record low of 6.2% in the third quarter of 2021, the interest payment-to-disposable income ratio would rise to 8% after the four hikes this year, a level similar to that measured during the last monetary tightening. from 2018-2019. The more “dynamic” scenario could push it back to its level before the 2008-2009 recession. “A more ‘aggressive’ approach could lead to a correction in real estate prices, causing shocks to the economy and the financial system. »
Desjardins Group is also counting on four key rate increases this year, and on a normalization of the residential real estate market. However, the rise in mortgage rates should show its effects around the middle of 2022. The analysis suggests a price increase down to around 5%, compared to nearly 20% last year. “The rise in mortgage rates that will continue into 2023 will further dampen demand and could lead to a slight decline in prices of around 3% next year. Senior Economist Hélène Bégin adds, “Markets that are already overvalued, and also fueled by strong investor demand, such as Montreal, Ottawa and Toronto, are more vulnerable to a price adjustment in 2023.”
On the inflation side, Oxford predicts that it will oscillate around 5% at the start of the year, to slowly tend towards 2% in mid-2023. But there are risks. First, that upward pressures on wages modify inflationary expectations. Second, that inflationary pressures persist depending on the evolution of the pandemic and whether geopolitical tensions or other factors maintain their upward pressure on oil and gas prices.