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Faulty inflation forecasts hold Bank of Canada back on rate cuts

The Bank of Canada continues to navigate its battle against inflation cautiously, with Governor Tiff Macklem treading carefully on the possibility of rate cuts. Despite making strides in reining in inflation, Macklem remains wary of premature actions that could jeopardize the bank's credibility.

Economists anticipate that inflation will approach the desired two per cent mark by the end of the year, a significant achievement for the central bank. However, the specter of past criticisms looms large, particularly regarding earlier inflation projections that missed the mark.

For Macklem and the bank's governing council, confidence in inflation forecasts is paramount before considering rate cuts. However, past forecasting inaccuracies have eroded some of this confidence. Stephen Gordon, an economics professor at Université Laval, emphasizes the importance of having faith in these forecasts before taking action.

Macklem assumed the governorship amidst the COVID-19 crisis in June 2020, with an initial commitment to keeping rates low for an extended period. This pledge fueled a surge in Canada's housing market, contributing to inflationary pressures. The subsequent rate hikes initiated in March 2022 aimed to address these pressures but left some borrowers, who had acted on Macklem's earlier guidance, facing higher mortgage payments.

Although inflation moderated to 2.8 per cent in February, it remains outside the bank's target band of one to three per cent for much of the recent past. The bank's credibility has taken a hit, with a majority of economists expressing concerns about the delayed return to target inflation.

Despite Canada's economy not showing signs of weakness necessitating rate cuts, there are ongoing debates about the timing of such actions. Derek Holt of the Bank of Nova Scotia warns against easing too soon, highlighting the potential risks of such a move on Macklem's leadership and the economy.

The real estate market dynamics further complicate the situation, with strong demand and limited supply already exerting upward pressure on prices. Political pressures add another layer of complexity, with calls for rate cuts from some quarters, while others warn against allowing inflation to spiral out of control.

Market indicators suggest uncertainty regarding the timing of rate cuts, with traders and economists offering differing opinions on when such actions might occur. Despite the challenges, Macklem and the Bank of Canada continue to weigh their options carefully, mindful of the implications of their decisions on inflation, credibility, and the broader economy.



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