The Bank of Canada runs the risk of depressing an already fragile economy by waiting too long to cut interest rates, says a report from Moody’s Analytics.

Two years after the central bank began raising interest rates to curb soaring inflation, the timing of its next move has become critical, it said. The Bank of Canada held steady at 5 per cent earlier this month for the fifth meeting in a row, saying core inflation remains a concern and stressing that it was too early to talk about rate cuts.

The Bank’s “still-hawkish tone” quashed speculation of an April cut, but June remains on the table. The analysis by Moody’s senior economist Brendan LaCerda says the Canadian economy is clearly showing the strain of higher interest rates. Consumers have pulled back on their spending as homeowners renewing mortgages absorb steep payment increases and those who have yet to renew sock away savings.

Mortgage performance remains historically strong but delinquencies have been rising in recent months and charge-off rates on credit cards are back to pre-pandemic levels, the report said. Businesses too are reducing investment and hiring and the number filing for bankruptcy has started to climb.

“This economic state entails significant risk,” said LaCerda. “The current equilibrium is fragile. Should business sentiment suddenly turn more pessimistic, a swell in layoffs would convince consumers to retrench more severely, quickly sparking a downward spiral into recession.”

So far the labour market has held up, but growing slack will depress wage growth into 2024, removing a key support for consumers, he said. The strong economy in the United States that boosted exports and offset domestic weakness is also expected to slow.

“With these supports fading, the normalization of interest rates is crucial to the maintenance of growth through the latter half of 2024,” said LaCerda.

Getting the timing right is critical. Moving too early risks reigniting inflation pressures, especially in the housing market. “However, given that the bank has made core inflation a sticking point, the risk of waiting too long has much greater odds than moving too early,” he said.

While Moody’s agrees with the Bank of Canada’s gross domestic product projections for 2024, “there is some distance between” their inflation forecasts. The central bank’s current forecast of 2.4 per cent inflation by year end would mean only a modest deceleration from the 2.9 per cent pace that started the year, said the report.

“With the bank’s desire to wait and see further confirmation of core inflation’s deceleration, combined with the fact that the reported CPI data are lagged, policymakers risk delaying for too long,” said LaCerda.

It’s a view shared by other economists. David Rosenberg of Rosenberg Research and Ed Devlin of Devlin Capital said Monday on BNN Bloomberg that there is the risk the Bank of Canada will “over tighten” by waiting too long.

Rosenberg argues that the Canadian economy is already in recession, when taking into account its population boom. “So I think it’s too late in both directions. The bank acted too slow to raise rates. They acted too slow to cut rates,” he said.

Source: The Financial Post