Wartime Fiscal and Monetary Policy

Steve Saretsky -

Despite the market pressuring the Bank of Canada to begin liftoff and start hiking interest rates, they held firm once again this past week. The bank flagged the recent floods in BC and the emergence of the Omicron variant as air cover to stand pat. Per the official release,  “the Governing Council judges that in view of ongoing excess capacity, the economy continues to require considerable monetary policy support. We remain committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In the Bank’s October projection, this happens sometime in the middle quarters of 2022.”

In a follow up speech several days later, deputy governor at the Bank of Canada, Toni Gravelle, blamed supply chain bottlenecks as the root cause for stubbornly high inflation, suggesting these will eventually resolve themselves. There are a couple important takeaways here.

First off, let’s be clear, the Bank of Canada has no desire to raise rates. They are delaying as long as possible, trying to find any excuse to keep rates glued to the floor. The emergence of the Omicron variant is likely to provide adequate air cover. As the eloquent Jim Bianco pointed out on Twitter, whether you agree or disagree with how policy makers have handled COVID, any large spike in case counts will prompt politicians to ramp up restrictions. I do not hope for this, but it is the unfortunate reality. Omicron is coming to Canada and governments are likely to smash the panic button once again.

The UK is a great example. On Sunday evening, UK prime minister Boris Johnson took to the airwaves. “There is a tidal wave of Omicron coming, and I’m afraid it is now clear that two doses of vaccine are simply not enough to give the level of protection we all need,” Johnson said. The U.K. has raised its Covid alert level, and ramped up restrictions in recent days. Masks have been made mandatory in more public settings, and Britons have been told to work from home if possible.

It goes without saying this remains massively bullish for detached houses in the suburbs and likely delays the recovery for condos in the Downtown core.

Meanwhile, more COVID fighting stimulus is coming. The Canadian Government is set to pass Bill C-2, a $7B fiscal spending package which will extend subsidies under the Canada Emergency Wage Subsidy (CEWS), the Canada Emergency Rent Subsidy (CERS), and the Canada Recovery Hiring Program until May 7, 2022. I actually testified as a witness in the house of commons this past week, on precisely this bill. In short, I argued the stimulus is likely needed for the hospitality sector, but the ramifications of fiscal largesse are also showing up in asset prices such as housing.

In case policy makers, such as the Bank of Canada needed another excuse to delay tightening, the Trudeau Government is set to announce the updated monetary policy framework for the Bank of Canada today. It’s widely expected they will add a labour market component which provides the Bank additional flexibility to hold rates, even though inflation is above target. Again, don’t shoot the messenger, it is what it is. Policy makers are very predictable.

We are running wartime fiscal and monetary policy, except this time there are no guns, but a contagious virus.

Three Things I’m Watching:

1. Markets are pricing in at least 3 rate hikes from the Bank of Canada within the next 18 months. (Source: Acorn Macro Research)

2. Business owners are expecting to raise prices by almost 4.5% in the next year. Over half expect to raise by more than 5%. (Source: Ben Rabidoux)

3. Canadian household wealth is growing at its fastest pace in 30 years thanks to rampant asset inflation in housing and stocks. (Source: Bloomberg)

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The Saretsky Report. December 2022