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Benjamin Tal, the deputy chief economist at CIBC World Markets. (Courtesy CIBC)
The Bank of Canada is attempting to convince people it’s serious about decreasing inflation, which reached 6.9 per cent last month – the highest rate in 31 years.
CIBC managing director and deputy chief economist Benjamin Tal told an audience at the June 7 Land & Development conference at the Metro Toronto Convention Centre, however, that rising interest rates should be at least as big a concern.
The Bank of Canada increased its policy interest rate by half a percentage point on June 1 to 1.5 per cent as part of its effort to get the inflation rate back to its two per cent target.
“Two years from now, inflation will be two per cent,” said Tal. “It’s not about inflation. It’s about the cost of bringing inflation back to two per cent in terms of high interest rates.”
Capping interest rate at 2.5 per cent
Interest rates are expected to continue to rise quickly and could hit three per cent by late this year or early 2023 and according to some market forecasts could even hit 3.5 per cent.
“Just because the market is expecting it doesn’t mean that the market is right,” said Tal. “The market can be wrong and has been wrong in the past.”
The Canadian housing market is slowing down rapidly and Tal believes it will soon be balanced, which is a good thing, and that will be followed by a buyers’ market.
“I need to see inflation starting to behave and the housing market slowing in order to make the point that there’s no need for interest rates to go beyond 2.5 per cent,” Tal said.
“I can tell you that the difference between 2.5 and 3.5 per cent is the difference between no recession and a recession. It’s as simple as that.”
Tal expects rents to rise at a faster rate than home prices over the next few years after homebuyers benefited from several years of very low interest rates.
“When you accelerate activity, you borrow from the future and the future has arrived with interest rates rising,” Tal explained.
Energy costs and inflation
Tal said the war in Ukraine and continuing deglobalization are inflationary, and moves by European countries to cut or eliminate their dependence on Russian oil and gas are driving up global energy prices.
Economies are experiencing an “oil shock” and Tal said responses to oil shocks lead to recessions via higher interest rates. Economies are, however, less oil-intensive than in the past and dependence on the fuel is falling.
“Our susceptibility to higher oil prices has diminished over time, and that’s a good thing,” said Tal, who claimed not to be losing sleep over energy-induced inflation. “Oil prices are rising, but investment in Alberta is not rising.
“This is the first time we’ve seen something like that.”
Supply chain issues and COVID-19
Supply chain issues and a “sick supply system” are causing prices to rise and are responsible for 60 to 70 per cent of inflation, according to Tal. He said inflation won’t be a major issue if that factor can be brought under control.
“The demand shock is COVID and the supply shortage is COVID. That will diminish.”
Tal believes another COVID-19 variant is coming that will impact lives, but won’t derail economies and will be economically manageable.
“2022 is still a transition year from a pandemic to an endemic,” he said.
More flexible labour market
The coronavirus made the labour market more flexible and increased remote working. People in lower-paying service industry jobs decreased dramatically at the beginning of the pandemic because fewer services were being offered and governments were funding workers.
Young Canadians have now re-entered the labour market.
Tal said it’s difficult to find people to fill low-paying jobs and they often don’t remain in these positions for long as people in the service sector have bargaining power for the first time.
Immigration per capita is increasing much more in Canada than in the United States and non-permanent residents and international students are applying to become permanent residents of the country.
Seventy per cent of new “immigrants” were already living in Canada and they’re largely younger, more educated, can speak English, have some work experience and are more employable, Tal noted.
However, Tal believes Canada’s immigration system must be fine-tuned because of the 400,000 immigrants targeted this year none are badly needed nurses and construction workers.
“The No. 1 issue facing (housing) supply now is construction labour because we don’t have enough of it. The cost of construction means that it’s much more difficult to complete a project on schedule. It can be double the time, and time is money.”
Rising costs are curtailing development
Tal said rising development charges and taxes, as well as the introduction of inclusionary zoning regulations in some markets, are compounding the difficulties caused by rising construction costs and labour shortages.
Developers’ profit margins are shrinking due to construction costs rising faster than inflation and home prices, and this is leading to cancelled or postponed projects. That means thousands of badly needed housing units aren’t being built.
“We need a rental solution to this crisis,” said Tal. “We need a purpose-built solution.
“We need to support this industry as opposed to punishing it. I fear that the next two years will remove the sense of urgency to do something about it and that’s exactly the opposite of what we should be doing.”
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