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Rudyard Griffiths: Don’t expect the Bank of Canada to stop hiking rates anytime soon

Commentary

Last week’s surprise interest rate hike by the Bank of Canada caught markets and investors off guard.

The working hypothesis going into the rate decision was that more than a month or so of higher-than-anticipated GDP growth and flatlining inflation would be needed to force Governor Tiff Macklem off the sidelines and back into hiking mode. So why the surprise hike? And, more importantly, what does the end of the Bank’s extended six-month pause in the current rate cycle tell us about the future trajectory of monetary policy? Something is afoot, but what?

There is a worrying set of indicators that the overnight lending rate, the central banks’ primary tool to control inflation, has become significantly less effective than we assumed even six short months ago. Inflation is becoming sticky, and this has to do increasingly with factors that are outside the Bank of Canada’s control.

Exhibit A for the case for inflation, as well as rates being “higher for longer,” in Canada is mass immigration. Canada’s outsized population growth, in excess of three percent in a single year, is pushing supply further out of sync with demand and goosing personal consumption in ways that have wrong-footed the Bank of Canada. A rule of thumb is that for each percent of population we add, GDP grows by a similar amount. Add three percent-plus population in twelve months and you are priming the economy in a way that counters the monetary policies of Governor Macklem. In short, continuing record immigration levels this year and for the foreseeable future will make the Bank’s job a lot harder and suggest that last week’s hike is likely the first in a series of hikes, not one and done.

The second factor working against the blunt instrument of monetary policy and its attempts to rebalance supply and demand is fiscal policy. And here it isn’t simply the current government’s alphabet soup of programs and priorities that is inflationary. What is new in the current inflationary fight is the sheer scale of public debts. This matters as we have never before hiked interest rates this fast against the backdrop of federal and provincial debt running at 75 percent of GDP.

To state the obvious, every percent increase in the bank rate creates a corresponding surge in deficit spending related to interest payments. These payments are injected directly into the economy further stimulating demand (three-quarters of government bonds are held domestically). Yes, these payments generally go to the upper quintiles of income earners, pension funds, etc. but we are talking big numbers when you go from almost zero interest rates to close to five percent in just over a year.

Total federal and provincial debt interest payments for this year are estimated at a whopping $68 billion or the equivalent of the entire annual benefits of the CPP and QPP pension plans. That is up thirty percent over the previous twelve months and will continue to increase as governments borrow aggressively to fund record deficits against a backdrop of steadily rising interest rates orchestrated by their very own central banks.

The tsunami of interest payments from both levels of governments to domestic bondholders is a not-so-mini “doom loop” that explains, in part, why the six-month pause on hikes was a bust. Going forward the salutary effects of future hikes will continue to be blunted by ever-increasing cash transfers from government, to the tune of tens of billions of dollars, going again directly into the economy via interest payments. It seems like debts and deficits matter not in the abstract as a long-term burden on future generations but as an accelerant of inflation in the here and now that is compounding the more rates rise.

The last consequential and ongoing development that is undoing the demand-destroying effects of Governor Macklem’s monetary policy is how commercial banks have chosen to respond to higher rates. Instead of passing rate hikes through to mortgage holders in the form of higher debt servicing costs as was the practice in past rate cycles, lenders are “innovating” and permitting the largescale negative amortization of mortgages. This is where the borrower continues to make a fixed payment with the unpaid interest added to a growing principal. Undeniably this is helping keep possibly tens of thousands of people in their homes and ensure that a glut of foreclosures and forced sales don’t cause a plunge in national home prices, albeit at the cost to borrowers of larger, ever-increasing loan principals.  

Bank of Canada Governor Tiff Macklem on April 13, 2022, in Ottawa. Adrian Wyld/The Canadian Press.

But the banks’ “extend and pretend” debt servicing policy, affecting tens of billions of dollars of mortgage debt, is undeniably blunting the effects of rate hikes. Put another way, the bank rate has to bite somewhere. One-third of Canadians who own a home have no mortgage debt and as such aren’t affected by higher rates. Absent extracting a pound of flesh from homeowners who have significant debt, monetary policy struggles to get meaningful traction on the economy as seen in the latest GDP numbers which show continuing high levels of consumer spending in defiance of higher rates. 

So where does all this leave the Bank of Canada and its inflation fight?

Combined, these anti-disinflationary forces and policies suggest that the much-discussed “stickiness” we are seeing when it comes to the consumer price index may not really be a story of the after-effects of snarled supply chains, the disruption of the war in Ukraine or pandemic-related personal savings or, in other words, the usual excuses for persistent inflation we continue to get from central bankers. Rather, this time could be different, that the backdrop for the current inflation fight is much more specific to this moment, and its dynamics encompassing the reality that Canada is a high-debt, high-immigration country that has bet the proverbial farm on real estate and, as such, cannot let monetary policy work on debtors in its usual cruel and efficient way.

To Tiff Macklem’s credit, he is resolute about returning inflation to the Bank’s two percent target. His determination combined with anti-disinflationary forces at work in Canada strongly indicates that this week’s hike will not be the Bank’s last.

A much higher terminal rate for this cycle (well north of five percent) is likely in our near-term future. And yes, monetary policy will finally win out over inflation but at a significant cost to the economy and to our national stores of wealth, like housing. As the old saw goes “There ain’t no such thing as a free lunch.” Our generation’s fight against inflation didn’t have to end with what will likely be a painful and protracted recession brought on by crushing interest rates. We could have learned from the experiences of the 1970s. Instead, we have created a dangerous brew of forces and policies, increasingly hardwired into our economy, that are acting against monetary policy. The bill is now coming due for these policy choices. It’s a big one and it’s going to hurt.

Malcolm Jolley: Insider wines for everyone: Touring Italian label G.D. Vajra’s winery

Commentary

Francesca Vaira is showing us the tree in the middle of the wine cellar at G.D. Vajra, her family’s winery not far from the town of Barolo. Or is it outside of the cellar? In fact it’s both. The tree is in a courtyard, glassed in from the cellar, which allows for natural light among the large oak botti vats used for elevating Vajra wines.

The tree is small, not a miniature like a bonsai, but diminutive because it does not receive much if any direct sunlight. Nor does direct sunlight reach the level of the windows of the large courtyard in the middle of a very large cellar. The indirect light that comes in is not hot, just illuminating.

The natural light is also pleasant, which Francesca explains is the point. Her family and those that work with them in the cellar will spend a lot of time working in what is usually a damp and dark place. The open-air terrarium of the courtyard is meant to soothe the souls of the people who work in the cellar.

My son, Alec (20) and I traveled to Piedmont in Northwestern Italy last week after attending a family event in the U.K. I had reached out to Francesca Vaira after sitting next to her at a dinner that was part of a press trip I took about five years ago. Her wines, the G.D. Vajra wines, were my favourite at the table. The Vajra wines are certainly renowned and celebrated in Barolo and beyond (and priced accordingly), but they’re also, in my humble opinion, an insider’s wine.

The winery visit was beginning to give me an insight into why G.D. Vajra occupies its own niche in the Langhe, the rolling white dirt hills in the southern shadow of the Alps, that famously makes the wines of Barolo and Barbaresco. Before visiting the tree, we began our tour in the fermentation cellar. There, giant stainless steel tanks are illuminated by long floor-to-ceiling panels of stained glass.

When Francesca’s parents, Aldo and Milena Vaira, built the fermentation cellar in the 1980’s they commissioned the renowned Franciscan monk-turned-artist Father Costantino Ruggeri to design the stained glass windows, which evoke the later collage works of Henri Matisse.

Just like the tree in the courtyard, the stained glass is meant to raise the spirits of the people working long hours in the winery. Those hours are especially long and protracted at Vajra, where they make wine from several varieties; not just Nebbiolo, but other reds like Dolcetto, Barbera, and Freisa as well as whites like Chardonnay, Sauvignon Blanc, Riesling, and the rare indigenous Piemontese grape Nascetta.

Different grapes ripen and mature at different times, so harvest at Vajra can last several weeks over a couple of months. As if to prove the purpose of the art in a utilitarian setting, Francesca bends over to move a large hose out of the way. The concrete floor is illuminated in primary blue, yellow, and red hues from the morning sunshine, and it’s hard not to feel uplifted, even for a small moment.

The Vaira family standard of care, of course, extends beyond how they treat their people. G.D. Vajra began as a kind of double act of rebellion in the tumultuous year of 1968. Teenage Aldo Vaira was a city kid attracted to the street demonstrations in Turin. His parents thought shipping him to stay with relations in the countryside would tame his rebellious nature.

The move backfired as Aldo became determined to resurrect the family tradition of farming, and particularly winemaking. By the time he had established the G.D. Vajra label, keeping for fun the misspelling from an old clerical error, he was farming organically and pioneering the ecological winemaking movement in the Langhe and Italy. This ethos was and is firmly shared by his wife Milena, daughter Francesca, and her two brothers Guiseppe and Isodoro, who now act as winemaker and vineyard manager, respectively.

Francesca Vaira at G.D. Vajra, Barolo, Italy. Credit: Alec Jolley.

As a young journalist, I was taught the inverted pyramid method, where one tries to get as much pertinent information into the first few paragraphs of a story on the presumption that most readers will stop after that, and if they don’t it’s because they’ve been hooked by that initial barrage of information. This column is surely proof that I have abandoned that technique, but on the subject of all the wines we tasted with Francesca, it may be worth beginning with the four Barolo wines, since they’re ultimately what the label is most famous for.

We started with the Albe 2019, their gateway Barolo, which is a blend of several of the Vajra vineyards. It’s recognizable from its bright and inviting label, which Francesca explained is meant to attract and reassure consumers unsure about trying Barolo. It generally retails at around $50 a bottle, which makes it a deal for the category. It’s a clear and classic Barolo, with notes of roses and tar over bright cherry. Just released, it’s young and grippy with tannins, but friendly with a bit of air.

The Albe was followed by three single vineyard Barolo. First, the Costa di Rose 2019, with more red fruit and some minty herbal character. Then, the Ravera 2019, more cherry, rose, and that herbal character, but maybe somehow a little more resonant. Finally, the Bricco del Viole, from the highest vineyard. Viole means violets, and it may be the suggestion of the name that evokes some of the darker cherry-to-black fruit notes I caught. All these wines were just released and very young, but absolutely delicious. One can only imagine how they’ll sing in a decade’s time or more.

Before we hit the Barolo, we tasted the Langhe Nebbiolo 2022, made from young vines not ready yet for the major labels. Clean, clear full of red fruit, and still well structured with fruit tannin. We tried the Claré JC Langhe Nebbiolo 2022, a pet project of Guiseppe Vaira. The Claré is meant to evoke pre-modern reds of the Langhe; ones that Thomas Jefferson, the 18th century’s greatest wine critic, admired. The irony is that it tastes (to me) thoroughly modern, clean, and certainly clear (like Claret) with juicy and moreish cherry notes.

The G.D. Vajra Kyè Langhe Freisa 2020 that we tasted also reflected the ethos of the Vaira family as well as any of their fine wines. Freisa is an old Piedmont red grape that was going the way of extinction until the efforts of winemakers like Aldo Vaira to preserve and replant it. Often made in a light quaffable style, as a kind of afterthought to making Nebbiolo or Barbera, Vajra shows it respect and makes a wine from it that is as serious as it is complex and delicious. Peppery and brooding with dark cherry, an enervating acid lift, and enough fruit tannin to hold it together. Wines made with love will always give it back.

G.D. Vajra wines can be found throughout Canada, subject to availability, etc. Google them with your home province, or contact me through comments or Twitter or mjwinebox.com and I’ll send you agent information.