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Inflation Targeting

Steve Saretsky -

Love him or hate him, Bank of Canada Governor Stephen Poloz is on the way out. Poloz has been lauded for his near perfection in managing inflation, earning him the Central Banker of the year award in 2018.  During his tenure, the Consumer Price Index has stayed within the central bank’s comfort zone for inflation 92% of the time, a better record than any governor since the central bank started targeting inflation in the early 1990s.

However, there are certainly debates over the accuracy, or for that matter the relevancy of the consumer price index, which tends to disguise real inflation for you average hard working Canadian. In fact, if you were to ask any young or middle age citizen how much, on average, the cost of living was rising each year, you’d most certainly get an answer higher than 2%. Once dubbed “The Candyman”, Poloz’s lower for longer stance on interest rates encouraged household debt levels to reach unsustainable levels, and allowed house prices to detach from incomes. Both of which have reached a point of no return.

I’ll be the first to admit, Poloz was merely following his Central banking peers, caught between a rock and a hard place. As Poloz remarked in his final interview with Kevin Carmichael of the Financial Post, “I know counterfactuals are very hard for people to envision, especially when it’s way in the back, so they just look at it and say, `Wow, you kept interest rates really low and, therefore, the housing market really expanded and that caused all of this to happen, all of this debt and these vulnerabilities.’ Well, no, that was instead of a drawn-out recession, possibly a depression. So aren’t we far better off?”

And therein lies the million dollar question, are we better off? Certainly for a large portion of the demographic that is the case. Asset prices have inflated, enriching those fortunate enough to be in the ranks of homeownership. For those who missed out, and were left behind, it appears to be a near impossible mountain to overcome. How will this wealth transfer, or lack thereof, impact future generations?

Perhaps Stephen Poloz’s tenure, and those who came before him, should be ultimately scored many years down the road. After all, our monetary and economic framework is being put to the  test during this pandemic. While asset prices remain elevated near all time highs, a sign of success for central bankers, that may not bode well for the near 20% of those who are currently unemployed, and the 31% of Canadians who don’t own a home but are desperate to get on the housing ladder. The usual playbook of increasing affordability via lower borrowing costs appears to have run its course. Mortgage rates have only dropped a mere 17 basis points during the pandemic and have been range bound for years. Compare that to a 186 basis point drop after the financial crisis, or a 549 basis point drop in the early 1990’s recession. In other words, unless home prices decline significantly, housing affordability will fail to improve. Of course, declining home prices conflicts with central bank policy, which has had the desired outcome of generating economic growth through the wealth effect generated by higher asset prices.

If the past decade was any indication as to the benefits of QE, then the wealth gap is set to blow out to new heights. The Bank of Canada has more than tripled its balance sheet over the past few months.

And while Canadians are simply unaware, or much too polite to say anything, it is clear there’s a level of understanding that something isn’t quite right. A level of social unrest is brewing. Homeownership rates peaked a few years ago and will continue to decline but, hey, at least CPI was near 2%.

Three Things I’m Watching:

1. Something worth considering, but how stimulative are today’s mortgage rates? We are in a deep recession and mortgage rates have fallen a measly 17bps.

2. Early 1990s rate cuts boosted affordability by 120%. Post-GFC lower rates increased affordability by 40%. This time, it’s been less than 10%,

3. Share of mortgage deferrals has been highest amongst younger, lower income mortgage holders.

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The Saretsky Report. December 2022