ANALYSIS | Rising optimism sounds great unless central banks decide we’re simply too upbeat | CBC News

At first glance, the reappearance of “sold over asking” real estate signs may seem like an encouraging signal for the Canadian economy, especially for highly invested homeowners who have watched prices fall from last year’s highs.

But a growing number of economists worry that a series of recent indicators, the latest being Wednesday’s rise in Canadian retail sales, may instead be a red flag for central bankers, goading them into more rate hikes that could ultimately make many Canadians feel miserable.

With each new smidgen of optimistic data, money market traders point to a rising chance that central bankers will raise rates again. A growing number of Canadian bank economists agree there will be another rise in interest rates when the Bank of Canada’s Tiff Macklem announces his rate decision on July 12.

Rate hike ‘baked in’

“We expect that there is a 25-basis-point hike baked in for July,” said RBC economist Carrie Freestone on Wednesday, using economist-speak for a quarter percentage point, shortly after the retail figures came out.

That will mean more pain for short-term and floating-rate borrowers, whose interest costs rise with the Bank of Canada overnight rate.

Borrowers looking for longer-term fixed-rate loans are more directly affected by the Federal Reserve, the U.S. central bank that paused last week after 10 consecutive rate increases while warning that two more quarter-point rises are likely before the year is out.

Fed chair Jerome Powell reiterated that warning in front of a hostile U.S. congressional committee on Wednesday.

“Inflation pressures continue to run high and the process of getting inflation back down to two per cent has a long way to go,” Powell testified to the House Financial Services Committee.

The fact is very few people, including members of Congress, like rising interest rates. Stock prices, which have recently been on the upswing, slumped after Powell spoke.

The continued surge in the price of everything, long after prices were supposed to be contained by rising interest rates, is not just a U.S. and Canadian phenomenon. As the Wall Street Journal reported this week, “inflation around the world just won’t go away.”

Buoyant global outlook

Policymakers worry that the effect of rate hikes are ebbing, the Journal reported. A decline in house prices seems to have stopped and unemployment has begun to fall again.

“Canada, Sweden, Japan and the U.K. skirted recessions after growth unexpectedly rebounded,” said the Wall Street Journal report. “Business surveys suggest a relatively buoyant outlook.”

In the U.S., there have been many reports that a persistently rising stock market is making the Federal Reserve nervous. In the Journal’s words, a rising market was telling Powell, “You haven’t done enough.”

BMO’s chief economist, Doug Porter, echoed that point in a recent market overview.

“The Canadian housing market is sending the Bank of Canada the same message,” he wrote, noting that sales have now rebounded to last year’s levels, and prices are rising, too.

Thus, we’re seeing the return of “sold over asking” signs.

“We suspect that for all the Bank [of Canada]’s talk about Q1 GDP [economic growth], April CPI [inflation] and a strong job market, the rekindling in the housing market really hit a nerve,” said Porter.

And that may mean continuing rate hikes until house buyers feel the effect. Conventional economics tells us that if interest rates go high enough, even with a housing shortage, eventually no one will be able to afford a loan to pay high house prices. But evidently, we have not reached that point.

More spending, but not so much stuff

The latest retail data does indicate that some consumers are beginning to feel the pinch as borrowing costs and prices outpace incomes. 

While retail sales were up more than one per cent in dollar terms, consumers were not getting as much for their money. The actual amount of stuff they were able to buy only rose by a third of a per cent and sales of things like furniture and appliances, which many people borrow to buy, actually fell. 

As RBC’s Carrie Freestone noted in a CBC interview on Wednesday, before the Bank of Canada makes its decision, there are plenty more indicators besides retail sales and houses to show whether prices are responding to the central bank’s action, including new inflation numbers and employment data. 

Central bankers both here and in the U.S. have warned repeatedly about inflationary expectations, a self-fulfilling prophecy that makes prices keep rising because people expect higher prices. But it may be that Macklem and Powell face a different kind of expectation, where people refuse to believe that a rising economy is about to end.

Certainly Canadians who learned to ignore nearly two decades of gloomy predictions about housing and thus profited from enormous returns in an unquenchable residential real estate market may be difficult to convince.

That continued optimism is hard to reconcile with the latest round of warnings from banks and regulators that serious bad news could be around the corner. The latest warning was from the Office of the Superintendent of Financial Institutions, which raised capital requirements again as “insurance” for a coming financial storm.

“Today’s decision reflects our assessment that financial system vulnerabilities remain elevated and in some cases have continued to increase,” said banking regulator Peter Routledge this week. “Households and [companies] remain highly leveraged, making them more vulnerable to economic shock.” 

But until that shock comes, many Canadians who have heard similar warnings before may not be inclined to listen.