Central bank gambles Canadians won't get into the inflation habit: Don Pittis

Canadian borrowers fearful of another hike in Bank of Canada interest rates are likely off the hook for three months at least.

There is a tiny chancecentral bankgovernor Stephen Poloz and his deputy CarolynWilkinscould raise rates at the next meeting on May 30, but since there is no news conference scheduled to explain their actions, it's likely the nextopportunity to hike won't be until July.

But the governors made it very clear at yesterday's meet-the-media session that Canadians must be prepared for a series of future interest rate increases.

"Our uncertainty is about how much and at what pace," said Poloz.

Housing slowdown

The bank'sresearch shows housing activity "contracted sharply in the first quarter," according to the Monetary Policy Report. But Polozattributes most of that decline to people responding to new, stricter mortgage rules that kicked in Jan. 1by rushing their plans to buy.

Effectively, the real estate business that would have happened at the beginning of this year moved to the last few months of 2017 to beat the new stress tests, making the contrast between the two periods even more dramatic.

Poloz says that, and a temporary bottleneck in rail traffic that cut into exports, will begin to disappear from the economic data any time now, causing a sharp return to economic growth.

Bargain rates yieldresults

Overall yesterday'sreport contained good news. For years, bargain-basement interest rates have failed to spark inflation into life, but now there are clear signs the economy is kicking intogear.

Statistics Canada said in March that the annualinflation rate rose to 2.2per centin February, from 1.7 the month before.

The pause in rate increases comeswhile the central bank waits for more data on the futureof theeconomy and inflation. While the bank is confident growth will continue, there are several reasons the pace of that growth remains uncertain.

While talk of completing a NAFTA renegotiation with the U.S. and Mexico has become more optimistic in the last month, the bank says there are still signseconomic capacity the ability of Canada to produce goods and services isn't increasing as fast as Polozhad hoped.

Trade uncertainty and confusion over whether U.S. tax cuts would make it better to invest south of the border may have slowed Canadian business investment, not in real terms but compared to what would have happened without those uncertainties.

Rate reaction nightmare?

Bank of Canada researchers also want a better reading on consumer reaction to rising interest rates. Wilkinshas said high Canadian household debt levels as interest rates rise keep her awake at night.

The bank says Canadians are beginning to rein in their debt.The difficult question for Wilkins and Polozis how strongly Canadians will respond to recent rate rises, and perhaps even more unpredictable, how they will respond to the prospect of more increases to come.

According to yesterday's report, the neutral rate, the interest rate that would neither stimulate nor slow the economy,is between 2.5 and 3.5 per cent, well above the bank's current 1.5 per cent level.

The other thing that the bank wants to research before it makes another move is the Canadian reaction to inflation itself.

After years when prices hardly moved there is a growing perception that prices are rising faster than many people's wages.

Workers who receivedannual increments of between one and1.5 per cent in the past few years are beginning to realize their spending power is dwindling as the prices of their purchases go up by more than twoper cent.

Playing catch-up

"We have noted before that we would expect wages to be growing by around threeper cent in an economy operating close to capacity," said Poloz.

He sounded quite proud that the analysis by his team correctly predicted inflation would hit the midpoint of the bank's two per cent target about now.

That same team of analysts says inflation will go higher yet, significantly above two per cent in the coming year, but then fall back to two per cent in 2019.They say the economy will still need help from below-trend interest rates.

But for now, as they refrain from usingrates to keep a lid on inflation,Poloz and Wilkins will be hoping Canadian businesses planningto raise prices and wage earners hoping to catch up on more than a decade of losses have read the bank's predictions andwill keepsinging from the Bank of Canada's moderate-inflation song book.

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