This week the Bank affirmed its commitment to a cautious, some would say dovish approach to monetary policy. They made it clear that although interest rate increases will likely be required, they will be executed with caution with an eye on incoming data that will allow the assessment of the economy’s sensitivity to higher rates, the evolution of capacity and the dynamics of wage growth and inflation.
A large part of their press release was good news. Synchronized global growth is occurring and domestic growth is moderating but is expected to remain above potential for the second half of the year. The domestic output is being driven by “very strong” employment growth, increases in wages, higher levels of government spending, and continued business investment. On the downside, exports are not pulling their weight and housing is adjusting. As per their target, inflation is higher than expected and even core is firming. In the past, many of us have seen central banks raise rates after rattling off positive facts like that, particularly when we have been told that we are at or close to full capacity.
The Bank again said its policy actions will be data dependent but then shows us that it isn’t. I can’t imagine a tougher time for central bank watchers in this country than now. Both the Bank and the market see the data at the same time, but the market has no idea how that data will be assessed, weighed by “judgement” that seems contrived to be consistent with GC’s gut feeling. Looking at the preponderance of facts would suggest that we are at at full capacity and at unemployment levels consistent with full employment, seeing wages finally getting some traction and observing the participation rates climbing. This could, at the very least, suggest dropping the cautious stance. But drawing this conclusion from looking strictly at the data is insufficient to align with the Bank’s assessment. Don’t let facts get in the way of a good story. In their judgement, there is still ongoing slack in the labour market. Keep the foot on the accelerator.
Another example is the press release points out that upward revisions to historical national accounts data have left output at a higher level than expected, but their assessment is that this has had no effect on the output gap as the revisions imply the economy’s potential moved up commensurably. I guess in their judgement, lags between when potential is impacted from any increases in aggregate demand is pretty much simultaneous. My judgement would be that it is unlikely that newIy hired employees and recently deployed capital would contribute to increasing the country’s potential at the same rate as aggregate demand is moving but my judgement doesn’t matter, only GCs. This revised data will only give them ammunition to increase potential and move the stop sign further down the road, alluding to my last blog entry.
Until we decisively break from this period of economics behaving badly (questioning the Phillips curve, the low inflation mystery, uncertainty around trade, etc, etc), the market will continue to be at a high risk of being upended by this central bank. The Bank tells us that they will be data dependent, but rightly or wrongly, in the current environment, the Bank is instead applying liberal doses of judgement to that data. So for now, the incoming data should not be viewed as creating a defining, clear landscape picture but should be viewed as an abstract piece of art. Everyone will look at the same canvas but walk away with a different interpretation. As the data comes out, feel free to look at the facts and make your own assessment of how the economy is responding to higher rates (is housing slowing due to higher rates or macro prudential measures?), how capacity is evolving and look at the dynamics of wage growth and inflation but whatever conclusions you reach will be your assessment and unlikely to tell you anything about what GC is thinking and is about to do.
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