Ex-Bank of Canada Governor Poloz Sees Cracks in Consumer Resilience

Former Bank of Canada Governor Stephen Poloz says inflation is likely to cool faster than people are expecting, opening the door for lower interest rates.

(Bloomberg) — Former Bank of Canada Governor Stephen Poloz says inflation is likely to cool faster than people are expecting, opening the door for lower interest rates. 

The economist, who led Canada’s central bank from 2013 to 2020, said the country’s stronger-than-expected growth in the first half of the year was driven by population increases and the resolution of unique supply shocks from the pandemic. An early-year jump in household spending was likely a mirage, he said, driven by savings built up during the Covid lockdowns.

“I don’t think the consumer is as resilient as the data will make them look,” Poloz said in an interview.

Canada’s economy grew at a 3.1% annualized pace in the first quarter, which many analysts interpreted as proof that interest rates should rise further. Governor Tiff Macklem and the central bank’s policymakers did exactly that, boosting rates in June and July to bring the overnight lending rate to 5%, the highest since 2001. 

Poloz didn’t criticize the central bank or his successor. But he said it’s “just arithmetic” that Canadian households, which carry record levels of debt, will be more sensitive to higher rates than before the 2008 financial crisis. 

Many already started trimming spending last year, he said. It’s just taking a while for the bite of higher borrowing costs to fully show up in the data. 

For example, Canadian auto sales have been up every month this year. Some might view that as evidence rate hikes aren’t working, but Poloz said it likely reflects decisions made in 2022 to buy cars that couldn’t be delivered until 2023. Now, those cars are in garages, and consumers are feeling the weight of financing them. 

The former governor also cautioned that Canada’s low unemployment rate — 5.5%, near a record — shouldn’t be seen purely as the result of strong economic demand. There’s also an earthquake happening in the labor market, as an army of experienced workers retire. Even the youngest baby boomers are now about 60 years old. 

If policymakers misread those dynamics, they might keep rates high for too long, Poloz said. 

In the longer run, deflationary forces are at work, including the productivity-boosting power of the coming “fourth industrial revolution,” driven by data sharing and the rise of artificial intelligence, the former governor said.

“We have all the ingredients of a disinflation that’s pretty orderly,” Poloz said.

As for the risk of workers’ expectations reigniting inflation, Poloz is optimistic that productivity gains will act as a “wedge” between inflation and wage demands in coming years. If companies can produce more per hour of work, higher salaries for their workers don’t create the same price pressures, he argued. 

Despite his more sanguine view of inflation, Poloz said he understands central bankers’ recent moves to tighten policy as a prudent way to finish the job and get price pressures all the way back to the 2% target. He made the comments ahead of the release of data that showed the inflation rate accelerated to 3.3% in July. 

“The last thing I want to do is make a mistake and allow inflation to get stuck here, and that’s completely understandable,” the former governor said. “When you look out and it’s all foggy, when in doubt, keep your hand on the wall. That’s kind of your anchor point.”

Poloz nonetheless warned that the economy can look strong and still also have lower inflation if harder to measure supply disturbances are resolving in the background.

The Bank of Canada doesn’t see inflation returning to 2% until the second half of 2025, a timeline that was pushed back by six months at the July meeting. Most economists in a Bloomberg survey see the policy rate peaking at 5% before heading lower in the middle of 2024. Swaps traders aren’t so sure, and have all but fully priced another 25 basis points of tightening before the end of the year.

Poloz released a book titled The Next Age of Uncertainty last year, examining the economic forces that will shape the decades ahead, but he’s still wary of being too declarative in his outlook.

“We could have a recession, we could have stagflation, we could have a soft landing, or a softish landing. If someone gives you a definitive answer, they’re making it up. The tools don’t exist to do that,” he concluded. “As a business or as a household, prepare yourself for a range of possibilities.”

–With assistance from Laura Dhillon Kane.

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