Canadian borrowers hoping that the U.S. central bank would signal that rate hikes were over were once again disappointed after the Federal Reserve chair Jerome Powell not only hiked rates by a half a point to a 15-year high but promised more increases in the new year.
Just as in Canada last week, some optimists hoped a recent decline in U.S. inflation would mean a quarter-point increase in rates was all that was needed, followed by a pause.
But, while happy it was less than the previous four hikes of three quarters of a per cent, the vast majority of economists were resigned to the half-point increase.
“Let us say again for the record that we think this hiking cycle should be over right now,” wrote Tom Porcelli, chief U.S. economist at RBC Capital Markets in a research note before Powell spoke. “We have been fond of saying over recent months that the Fed is fighting yesterday’s war on inflation.”
But that is not how Powell and his advisers see it. The Fed chair warned that even the current rate, which remains lower than the 7.1 per cent rate of inflation, would not be enough to suppress price and wage growth.
Rates heading even higher
Not only did the bank increase rates to a range of 4.25 per cent to 4.5 per cent in this final policy decision of the year, but Powell insisted there could be several more interest-rate hikes in the coming year to remove what he called “the hardship that inflation is causing” and bring back stable prices.
“We continue to anticipate that ongoing increases will be appropriate in order to obtain a stance of monetary policy that is sufficiently restrictive to return inflation to two per cent over time,” Powell told reporters in a news conference Wednesday afternoon.
In fact, of the 19 Federal Reserve officials on the monetary policy committee, 17 offered independent estimates that the Fed’s target interest rates would have to rise above five per cent in 2023.
But the rates borrowers would have to pay would be much higher. Such a move next year would take U.S. prime rates, the interest cost offered to a commercial bank’s better customers, well above seven per cent.
And while those are U.S. rates, it is rare for the Bank of Canada to stray too far from the Fed’s levels. Also, Canadian borrowers may be affected when their banks need to back up the risks of long-term lending in the U.S. bond market.
At the Wednesday news conference, Powell persisted in the view that the U.S. could escape recession and he would not discuss the chance of stagflation, on the grounds that he would not address “hypotheticals.”
Stagflation is the phenomenon where inflation persists even as an economy slumps.
But while Powell hopes to avoid a sharp downturn, most economists interviewed by financial publications are skeptical, with a large majority saying a recession remains inevitable.
Both Powell and Bank of Canada Governor Tiff Macklem insist there will be no turning in their path to low inflation.
“Our top priority is getting inflation all the way back down to the two per cent target,” said Macklem in a Tuesday speech. But according some economists, Powell and Macklem may be in a sticky situation, in two senses.
Besides the conventional meaning of awkward or tricky, economists use the term “sticky” to mean any financial variable that resists quick change. Like wages and house prices, once people get used to current price level increases, inflation can be resistant to change, partly because everyone wants to catch up.
2 per cent or broke
The central bankers have “fallen well behind an inflation process that is likely to prove stickier than many currently expect,” wrote economist Mohamed El-Erian earlier this week. He favoured raising rates sooner.
While recent inflation numbers have come down from their peak levels in both the U.S. and Canada, a lot of that decline has been in goods, including gasoline.
Partly driven by the rising price of services, the Fed’s favourite measure of inflation — known as core inflation — that takes out volatile prices like gas, has remained stubbornly high at six per cent, three times the target inflation level.
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“There is reason from services alone to worry that inflation may well continue to overshoot Fed forecasts that have already been consistently revised up,” wrote El-Erian.
The economist worries that actually hitting the two percent target would do more damage to the economy than the bank would be willing to accept. While it won’t say so publicly, El-Erain believes the Fed knows it will have to make do with a higher target level closer to, say, four per cent.
No painless option
Asked directly about that option Powell was adamant.
“We’re not considering that and we’re not going to consider that under any circumstances,” he told reporters. “We’re going to keep our inflation target at two per cent. We’re going to use our tools to get inflation back to two per cent.”
As Canadian homeowners and borrowers know, sharp rises in interest rates hurt. Asked by one reporter about the pain that hiking the Fed rate above five per cent would cause, including in lost jobs, Powell insisted the pain of inflation was worse.
He said it would be worse again if, as in the 1970s, inflation expectations got so entrenched that the only solution was a deep recession and a long period of job losses.
He said interest rate rises continuing into next year will hurt, but much less than stopping rate hikes too soon..
“I wish there was a completely painless way to restore price stability,” said Powell. “There isn’t.”