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Central banks talk about inflation, but do they lose their credibility when interest rates do not move?

Central banks talk about inflation, but do they lose their credibility when interest rates do not move?

The Bank of Canada and the US Federal Reserve say they will really, really raise interest rates very, very soon.

But in separate press conferences on Wednesday, they made it clear that neither of them was ready to do so just yet.

As the Canadian dollar jumped above 80 cents US last week, many people were convinced that Bank of Canada Governor Tiff Macklem would act first and raise rates this week. He did not do it.

The postponement of an interest rate hike in Canada that so many expected has been described by one analyst as a “political faux pas” that could fan the flames of inflation and the housing market.

At Wednesday’s press conference, a reporter asked Macklem if he had lost the trust of Canadians after his inflation predictions turned out to be wrong.

Waiting for the Fed?

But rather than take drastic action to move the market, Macklem and his counterpart at the US Federal Reserve, Jerome Powell, acted in a way that seemed intended to broadcast a strong “keep calm.” And both focused on the strength of the North American economy.

The wild swings in global stock markets appeared to show traders were confident Powell was going to make his own big announcement. With few exceptions, Powell has just reiterated the Fed’s plan he previously announced in December.

While Powell nodded to the recent market turmoil, referring to “financial stability,” he said he was not worried because banks, businesses and households were in excellent shape. Central bankers insist that their actions focus only on such measures, known as the real economy. When they talk about short-term fluctuations in the currency or securities markets, they like to say that it is not for them to consider such things.

US Federal Reserve Chairman Jerome Powell on a screen at the New York Stock Exchange. No exciting and emotional action in the market on this week’s announcement as the bank stuck to a plan outlined in December. (Andrew Kelly/Reuters)

While Macklem may not like talking about the loonie, people as savvy as the Governor’s advisers to the Bank of Canada understand the economic impact of a rising Canadian dollar on trade if Canada begins to increase interest rates too before the United States. This may have left the impression that Macklem is waiting to be sure the Fed is indeed considering easing off before making its decision.

But of course, that wasn’t the reason Macklem gave for a delay. In fact, he said it wasn’t a delay, just a chance to give Canadians full warning that rate hikes are on the way, and he hopes they don’t hurt the strength of the Canadian economy. He also mentioned the continuing uncertainty about the effects of Omicron.

Despite the persistence of the pandemic, one of the most important indicators of strength in Canada and the United States has been the surprising health of the labor market.

Hikes won’t threaten the job market

While parts of Canada’s economy, such as those that rely on tourism, may not feel it yet, said Senior Deputy Governor Carolyn Rogers, who appeared Wednesday at the monetary policy announcement. for the first time since his appointment last year, evidence from the country as a whole was overwhelmingly positive.

“We are looking at a wide range of indicators and overall we have seen that employment participation rates have returned to near pre-pandemic levels, that there is pressure on wages and that employers are struggling to find employees for a high level of vacancies,” Rogers told reporters at Wednesday’s press conference.

“So in total these things are telling us that the labor market is tightening and the downturn is being absorbed,” she said.

Central banks talk about inflation, but do they lose their credibility when interest rates do not move?
This month’s snowstorm that hit Ottawa may have been another blow to the tourism sector, but other data shows that Canadian jobs have largely recovered from the downturn of the pandemic. (Justin Tang/The Canadian Press)

Powell had similar good news from the United States, insisting that the labor market was so strong that it was unlikely to be damaged by higher interest rates which are still expected later this year.

“I think there’s a lot of room to raise interest rates without threatening the labor market,” Powell told US financial reporters.

But when exactly would the Fed raise rates and how quickly? Despite the widespread belief that increases will take place in March and despite repeated requests from reporters, Powell was careful not to specify it.

When? It’s hard to predict

As he said in December, the US central bank will smoothly reduce its bond purchases – continuing but slowing the process of quantitative easing that the Fed has used to stimulate the economy – ending that process in March. Based on what the central bank has said in the past, this will pave the way for higher interest rates, which Powell says will be needed later this year.

“It’s not possible to predict with much confidence exactly what trajectory for our policy rate will turn out to be appropriate,” Powell said in response to a reporter’s question.

At the Bank of Canada press conference, Macklem was a bit more blunt.

“The emergency measures needed to support the economy during the pandemic are no longer needed,” Macklem said. “Interest rates need to rise to control inflation. Canadians should expect an upward trajectory in interest rates.”

WATCH | How economists are reacting to the Bank of Canada’s decision:

Central banks talk about inflation, but do they lose their credibility when interest rates do not move?

The Bank of Canada surprises by keeping its key rate at 0.25%

The Bank of Canada has decided not to raise its benchmark interest rate for the time being. Many economists had predicted an increase today due to inflation, which is currently at a 30-year high of 4.8%. 3:18

Currency traders who recently seemed certain the Bank of Canada would raise rates at this meeting are now betting that Macklem and Rogers will act at the next one. But Macklem made no promises.

Both Macklem and Powell said they expect inflation to fall steeply over the coming year. Powell, who had suggested last month that it would be back in the 2% target range by the end of 2022, hedged a bit, saying he now assumed it would be a bit higher. He suggested that supply constraints for some goods could last until 2023.

Macklem gave an inflation figure of 3% by the end of the year and in fact made the optimistic suggestion that the prices of certain products could fall as the supply chain unravels.

Unfortunately, while central bankers try to appear confident about the path of inflation, a look at their track record does not inspire confidence. And whether Macklem will truly demonstrate his independence and raise rates before Powell reveals a firm decision, that also remains uncertain.

Follow Don on Twitter @don_pittis