There may be a perfect storm on the horizon, and it’s leaving Canada’s central bank paralyzed. The Bank of Canada (BoC) held its key interest rate at 2.25%, a widely expected move. They warn that the economy faces slow growth and rising inflation—conditions that resemble a stagflation-like threat.
BoC Holds Rates On Stagflation-Like Conditions Surfacing
The BoC held its key interest rate at 2.25%, a level it has held for roughly 8 months and less than half of the 5.0% peak in 2023. Unfortunately, the lack of movement isn’t due to a Goldilocks economy where things are just right. It’s more like things are running too hot and too cold at the same time.
“Economic weakness combined with rising inflation is a dilemma for monetary policy,” said BoC Governor Tiff Macklem in this morning’s opening statement. “For now, holding the policy rate unchanged balances those risks.”
Stagflation is when an economy simultaneously faces rising inflation, stalling GDP, and elevated unemployment. No central banker will drop the S-bomb in public, but these are the conditions the BoC fears are materializing.
Canada’s Economy Is Stalling: Lower GDP, Elevated Unemployment
The central bank cited the mountain of weak economic indicators recently. GDP slipped 0.1% in Q1, housing activity is stalling, and employment has been “little changed since the start of the year,” notes the BoC’s decision.
Consumer spending rose 1.4%, but that wasn’t enough to offset weakness in housing, business investment, and broader economic growth.
There’s little doubt here—the economy is slowing in a way that’s hard to ignore. Normally, slower consumption and an economy that could use a jolt would present the need for rate cuts. The path to cheaper credit isn’t as clear this time.
Bank of Canada Sees Inflation Running Hot In The Near-Term
Annual growth of CPI inflation hit 2.8% in April, about 40% faster than the central bank’s target rate. They expect CPI to hover around 3% in the coming months, though oil prices are roughly $10/barrel above their estimates from April. Higher energy prices have helped some metrics like trade dollar volumes, but they also trickle into every aspect of the cost of living.
Rate cuts can help with the slowing economy and weak investments, but they will certainly boost inflation. That leaves the BoC with a rough tradeoff: cut too soon and risk fuelling inflation, or hold too long and deepen the slowdown.
“There may be a need for consecutive increases in the policy rate,” warned Governor Macklem.
Basically, as Friedman said in 1963, the root cause of inflation ‘always and everywhere is a monetary phenomenon’. So tying monetary policy (specifically the overnight rate) to inflation only works when lending is managed in the same way.
Basically when the broad money supply is expanded faster than gdp over a prolonged period of time, it causes inflation. To make this easier to understand, when there were 100B dollars of money in a 300B economy, those dollars were worth more than 300B in a 300B economy.
The term to describe this is ‘debasing’ the currency. In the past the king would take all the silver coins, and make them all thinner so you could double the number of coins without needing more silver.
Today, the money supply is made up primarily of bank notes, which are basically IOUs representing a debt from someone to a bank. So the more money leant out by banks (whether private or state owned) means that the money supply is being increased.
The theory behind MMP is that if interest rates are high, people can only afford to borrow a small amount, which reduces the total money supply. If rates drop, people can afford more debt, banks create more money to fund the debts, and increase the money supply. The problem is, simply, demand for money is almost infinately inelastic. That means that people will borrow money at 2%, 6%, 600%. So the impetus to manage the money supply MUST be on the banks not wanting to bankrupt everyone.
However, as we have seen, when the govt effectively bails out banks when they mess up, that impetus is gone. So in the case of Canada, the massive rise in the money supply is directly related to the increase in housing prices. Since banks can effectively pawn off most high risk mortgage debt on the govt, they have no problem increasing that principal, and the interest payments on it, since it doesn’t cost them any more to create 1M for a condo in Toronto in 2026 than it did to create 300K in 2013.
The problem is, when inflation takes hold outside of housing, it becomes an endemic problem. We cant drop the price of housing, since that would effectively double the national debt, and leave 20-35% of us bankrupt. We cant increase it anymore, since that would add more inflation, and prices for things are rising because people need to have a place to live. This is how you get stagflation.
I’m not sure if someone tracks this more precisely but the for sale listings on realtor have been going up by about 1000 per day for many weeks now. Granted the current total probably only represents 2% of the national total. Is everybody just hoping for the best?
Not sure what market you are referring to but in the GTA, the number of new listings on Toronto Real Estate Board’s MLS system is going down, not up, and sales are going up.