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Bank of Canada faces 'communication challenge' over rate cuts



Economists at TD Bank are anticipating a challenging communication scenario for the Bank of Canada if it decides to implement interest rate cuts this spring, especially given the current high housing costs. The central bank, widely expected to reduce its trendsetting interest rates this year, may face difficulties in conveying its message effectively.


In a recent report by TD economists Beata Caranci and James Orlando, it was emphasized that the potential rate cuts, amid above-target inflation and soaring shelter costs, could lead to confusion among the public. This, they pointed out, would create a "communication challenge" for the Bank of Canada in terms of anchoring household inflation expectations, particularly given the public's sensitivity to rising housing costs.


The authors highlighted the need for the Bank of Canada to shift its public communication convincingly to emphasize that shelter costs do not define broader inflation trends in Canada. Neglecting to do so, they warned, could result in leaving interest rates too high for an extended period, sacrificing economic growth in the process.


The report delved into the current state of inflation, noting evidence of a cooling trend across the consumer price index (CPI) despite elevated mortgage-related inflation. In November, the CPI increased by 3.1 percent on an annual basis, matching the previous month's figure. Notably, mortgage interest costs played a significant role in this rise, increasing by 29.8 percent year-over-year. Excluding these costs, the CPI would have been 2.2 percent, slightly above the Bank of Canada's inflation target of two percent.


The TD economists observed that the share of products in "deflationary territory" is increasing compared to pre-pandemic levels. Additionally, the number of products with inflation below three percent has risen, indicating a nuanced inflation landscape.


Addressing inflation expectations, the report warned that if interest rate cuts fuel demand and higher prices in the housing market, it may be challenging for the Bank of Canada to "re-anchor consumer expectations." The economists highlighted that households often anchor their inflation expectations based on personal experiences, with particular sensitivity to items with more extreme price movements, such as housing.


The report emphasized that there is ample research indicating that households tend to "overweight inflation expectations" related to items like housing, which has seen more pronounced shifts. The authors suggested that household expectations may be conditioned to be even more sensitive to price increases than the decade before the pandemic when inflation was relatively stable.


In summary, TD Bank economists predict that the Bank of Canada may face difficulties in effectively communicating its message if interest rate cuts coincide with high housing costs this spring. The report underscores the importance of the central bank clarifying the relationship between shelter costs and broader inflation trends to avoid potential economic growth sacrifices.


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