Until gas prices drop substantially or there are other clear signs of inflation easing, the Bank of Canada and the U.S. Federal Reserve Board are likely to stay on their current rate-hiking paths, says CIBC World Markets.
In a new report, the bank’s economists said the central banks are trying to walk the fine line of raising rates fast enough to bring inflation under control without plunging the economy into recession.
“By acting too slowly, and giving time for inflation expectations to build, they could leave a recession as the only tool for getting inflation back to earth,” the report said.
Indeed, if inflation expectations rise sharply, high inflation can become a self-fulfilling prophecy.
“For the time being, long-term inflation expectations seem fairly stable, both in Canada and the U.S.,” the report said.
However, it also said there’s a real risk of expectations diverging from reality, particularly as food and gas prices — which are “heavily weighted” in consumer expectations — remain elevated.
“A cooling of the housing market would certainly help, but grocery prices will continue to exert their powerful influence when people plan their summer BBQ,” the report said.
Given the fear of inflation expectations taking off, the central banks are hiking at a faster clip than usual, with 50 basis point hikes instead of the typical 25 basis point moves.
“We still see a mid-2% overnight rate as sufficient to contain growth and curtail domestic inflation pressures in both countries, but we’ve been moving up the timetable for reaching those yield peaks given the need to get some easing in inflation before expectations are de-anchored, and chances for a soft landing evaporate,” the report said.
“Unless we see a cooling in high profile prices for items like gasoline, the odds of a pause, or a shift to quarter point hikes, are now less likely until rates are at the terminal rates we’re projecting,” it concluded.