What is running hotter: stress or inflation?

Mundane Headline Goes Here...

Statistics Canada announced yesterday that inflation ticked upwards in April. Headline inflation moved from a lower than expected 4.3% in March to a slightly higher than expected 4.4% in April. And the first headline I saw was titled: "Cooling inflation might have been a false dawn" (insert exasperated, head-in-hands GIF here). Headlines like this frustrate me to no end. And lead to text messages that read: "I heard rates are going up now..." Maybe. Maybe not. No one really knows. And it struck me that maybe this rise in inflation is actually a good thing. 

Hear me out....

The downward path of inflation was never going to be linear. It peaked at 8.1% in June of last year. And in the ensuing 10 months, this has been the first deviation from the trend. That's pretty darn impressive overall. 9 good months. 1 bad month. But on the heels of this bad month, the probability of the Bank of Canada raising interest rates on June 7th just doubled (from 10% to 22% per Reuters).

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I think we can fairly assume that the Bank of Canada doesn't want to raise rates further. Make no mistake; they most certainly will if their hand is forced. But I don't think they're keen to unless absolutely necessary. And if it's true that interest rate increases take 12-18 months to bear out their full effect, there is a significant portion of the BoC's previous rate hikes that are about to come of age. Wind the clock back: 12 to 18 months ago, we had only seen 0.75% total increase to the BoC policy rate. From 8 to 11 months ago, there was an additional 2.25% tacked on. The full weight of this tightening cycle has yet to be felt. But it's coming.

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So why is that good news?

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The next best thing to a rate hike for the Bank of Canada is a credible threat of a rate hike. And April's inflation uptick lends a lot more credibility to that threat. See, the BoC can use tools like rate and money supply adjustments. But they also have another tool available: their dialogue and guidance. Their words. And those words are being overanalyzed six ways til Sunday. And based on the reaction we've seen so far, the fear of another rate hike could be enough to modify behaviour and expectations. And that might be the very thing that's needed for the BoC to sustain their pause.

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Economics isn't a discrete science like chemistry where outcomes can be controlled for. Economics is a social science that involves behavioural responses that can be, well....unpredictable to say the least. So as much as the BoC is trying to control the actual numbers and data points, a huge piece of their role is to influence our collective behaviour and expectations. If we expect things will get worse (read: more rate hikes), we're likely to hold off on those discretionary purchases just a little longer. And that makes getting inflation under control easier.

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The BoC knows there is more pain coming from their earlier hikes. There are already headlines coming out around businesses like Home Depot cutting their outlook for sales and Canadian Tire noting a shift in consumer spending on discretionary items. Headlines like these are likely to become pretty normal over the coming months as the economy continues to slow and behaviour continues to adjust. The general path is still projected to be downward for rates. There always exists a possibility that path is deviated from temporarily. But the coming months and years are still overwhelmingly expected to deliver us lower interest rates accompanied by hyperbolic and sensational headlines. Serenity now...

Wondering how all of this affects you or what to do about out? Reach out. We're more than happy to have a conversation. And hey, do us and a friend a favour and forward this along to someone in need of a deep, soothing breath.

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Take care out there!