Ted Rechtshaffen: Get ready for actions to speak louder than words next year

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They say actions speak louder than words, and that’s certainly true when it comes down to it Bank of Canada.

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The central bank is now forecasting consumer prices inflation CPI will return to two percent in mid-2025. If this two-year forecast has you worried that policymakers won’t cut rates for two years, don’t worry. It’s pretty amazing that he feels confident in making a two-year forecast. Keep in mind that just 18 months ago, the overnight rate was still 0.25 percent.

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Two years is forever in terms of economic forecasting, and as a result, based on the two percent CPI forecast until mid-2025, we should assume virtually nothing.

To show what I mean, let’s take a closer look at recent times interest rates were as high as in 2001.

When 2000 turned into 2001, the Bank of Canada rate was at six percent. Today it is 5.25 percent. At that time, real gross domestic product (GDP) grew by 4.7 percent and employment grew by 2.6 percent. Higher energy prices supported exports. There was growth in employment and wages, and along with tax cuts, this increased consumer spending.

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To help deal with an overheating economy, the Bank of Canada began raising rates starting in 1999, culminating in a 50 basis point increase in May 2000 to six per cent.

However, everything was not rosy. The tech bubble burst in the early 2000s and the year-end predictions for 2001 weren’t great. According to private sector forecasts, GDP growth was expected to fall to two to three percent. Concerns included the impact of previous interest rate hikes, higher energy prices and a general weakening of confidence.

As it turned out, Canada’s GDP fell as low as 1.79 percent in 2001 from 5.18 percent in 2000. Unemployment was 6.83 percent in 2000 (much higher than today’s rate), but rose to 7.22 percent in 2001 and 2.6 percent in 2000.

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The Bank of Canada kept its rate at six percent during the second half of the 2000s, but as the economy weakened, it felt it was time to cut. Policymakers cut the rate by 25 basis points in January 2001, and by the time the cut was completed a year later, the rate was 2.25 percent, a full 375 basis point cut in one year.

Did the Bank of Canada predict these moves in May 2000? No, it wasn’t. At the time, higher inflation was clearly feared.

The Bank of Canada building in Ottawa.
The Bank of Canada building in Ottawa. Photo by Adrian Wyld/The Canadian Press

The May 2000 Bank of Canada Monetary Policy Report stated: “… (we see) several key areas of uncertainty for the conduct of Canadian monetary policy going forward. First, demand dynamics in Canada from both international and domestic sources could continue to beat expectations. Second, a possible increase in inflationary pressures in the United States could have implications for Canada. Third, capacity Canadian economy to produce goods and services without increasing inflationary pressures may be higher than previously thought.

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That’s not a knock on the May 2000 Bank of Canada opinion, although it might be instructive as to why you might not want to make a two-year forecast of when CPI will return to two per cent.

A slowdown in the economy was clearly ahead, but things got much worse when the completely unpredictable 9/11 attacks in the United States occurred. This helped push the meaningful slowdown in 2001 to a much worse place.

Obviously, there are many differences between 2001 and today. What led to the run-up in interest rates in 1999 and 2000 was different from the reasons for today’s run-up. But some economic similarities are meaningful.

The monthly all-in CPI was just 0.66 percent in January 1999. As the economy improved, the CPI rose to 2.63 percent by December 1999 and was 3.2 percent in December 2000. At the time, the Bank of Canada raised its rate to six per cent in an attempt to calm inflation.

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Whatever slowed down the economy, the impact was dramatic. The CPI fell to 0.62 percent by November 2001. Now in catch-up mode to try to stimulate the economy, the central bank quickly cut the rate, finally stopping the decline in January 2002 when it fell to 2.25 percent.

Is this instructive for what the Bank of Canada will do next with interest rates? I think yes. The most important thing for me is that things can change quickly.

Eighteen months ago we had super low interest rates in Canada. Not so much today. At the end of 2000, it was six percent. In January 2002, it was 2.25 percent.

Over the past 30 years, the Bank of Canada has raised rates between 1.25 and 3.2 percentage points on six separate occasions (prior to the current significant rate hike). The one thing they all had in common was that it didn’t take long for each of them to be followed by a period of interest rate cuts ranging from 1.25 to 5.125 percentage points.

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As Blood, Sweat and Tears famously sang in 1968, “What goes up must come down.” Get ready for actions to speak louder than words on interest rates in the coming year.

Ted Rechtshaffen, MBA, CFP, CIM, is president, portfolio manager and financial planner at TriDelta Financial, a boutique wealth management firm focused on high net worth investment advisory and financial planning. You can contact him directly at tedr@tridelta.ca.

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