A Collective Sigh of Relief As The BoC Cut Rates For the First Time in 27 Months

General Leslie Blais 6 Jun

Today, the Bank of Canada boosted consumer and business confidence by cutting the overnight rate by 25 bps to 4.75% and pledged to continue reducing the size of its balance sheet. The news came on the heels of weaker-than-expected GDP growth in the final quarter of last year and Q1 of this year, accompanied by CPI inflation easing further in April to 2.7%. “The Bank’s preferred measures of core inflation also slowed, and three-month measures suggest continued downward momentum. Indicators of the breadth of price increases across components of the CPI have moved down further and are near their historical average.”

With continued evidence that underlying inflation is easing, the Governing Council agreed that monetary policy no longer needs to be as restrictive. Recent data has increased our confidence that inflation will continue to move towards the 2% target. Nonetheless, risks to the inflation outlook remain. “Governing Council is closely watching the evolution of core inflation and remains particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

As shown in the second chart below, the nominal overnight rate remains 215 basis points above the current median CPI inflation rate, which shows how restrictive monetary policy remains. The average of this measure of real (inflation-adjusted) interest rates in the past 30 years is just 60 bps. The overnight rate is headed for 3.0% by the end of next year.
Bottom Line

There are four more policy decision meetings before the end of this year. It wouldn’t surprise me to see at least three more quarter-point rate cuts this year. While the overnight rate is likely headed for 3.0%, it will remain well above the pre-COVID overnight rate of 1.75% as inflation trends towards 2%+ rather than the sub-2% average in the decade before COVID-19.
Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres
drsherrycooper@dominionlending.ca

March’s Weak Jobs Report Sets The Stage For A June Rate Cut

Latest News Leslie Blais 8 Apr

Today’s StatsCanada Labour Force Survey for March is much weaker than expected. Employment fell by 2,200, and the employment rate declined for the sixth consecutive month to 61.4%.

Total hours worked in March were virtually unchanged but up 0.7% compared with 12 months earlier.

The details were similar to the headline: as full-time jobs dipped, total hours worked fell 0.3%, and only two provinces managed job growth. Among the type of worker, a 29k drop in self-employment was the primary source of weakness, while private sector jobs managed a decent 15k gain. The issue for the Bank of Canada is that wage gains are not softening even with a rising jobless rate. Average hourly wages actually nudged up to a 5.1% y/y pace, now more than two percentage points above headline inflation. With productivity barely moving, these 5% gains will feed into costs and threaten to keep inflation sticky.

The unemployment rate in Canada jumped to 6.1% in March of 2024 from 5.8% in the earlier month, the highest since October of 2021, and sharply above market expectations of 5.9%. The result aligned with the Bank of Canada’s rhetoric that higher interest rates have a more significant impact on the Canadian labour market, strengthening the argument for doves in the BoC’s Governing Council that a rate cut may be due by the second quarter. The unemployed population jumped by 60,000 to 1.260 million, with 65% searching for jobs for over one month. Unemployment rose to an over-seven-year high for the youth (12.6% vs 11.6% in February) and grew at a softer pace for the core-aged population (5.2% vs 5%).In March, fewer people were employed in accommodation and food services (-27,000; -2.4%), wholesale and retail trade (-23,000; -0.8%), and professional, scientific, and technical services (-20,000; -1.0%). Employment increased in four industries, led by health care and social assistance (+40,000; +1.5%).

Average hourly wages among employees rose 5.1% (+$1.69 to $34.81) year over year in March, following growth of 5.0% in February (not seasonally adjusted). This is still too high for the Bank of Canada’s comfort.

Bottom Line

The central bank meets again next Wednesday, and a rate cut is unlikely. I still expect rate cuts to begin at the following meeting in June. The Canadian economy, though resilient, will suffer from rising mortgage costs as many mortgages come under renewal over the next two years. Delinquency rates have already risen. Moreover, the planned reduction in temporary residents will also slow economic activity.

With the US jobs market still booming, it is likely the BoC will begin cutting rates before the Fed.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres
drsherrycooper@dominionlending.ca

Canadian Inflation Falls to 2.9% in January, Boosting Rate Cut Prospects

General Leslie Blais 20 Feb

The Consumer Price Index (CPI) rose 2.9% year-over-year in January, down sharply from December’s 3.4% reading. The most significant contributor to the deceleration was a 4% decline in y/y gasoline prices, compared to a 1.4% rise the month before (see chart below). Excluding gasoline, headline CPI slowed to 3.2% y/y, down from 3.5% in December.

Headline inflation of 2.9% marks the first time since June that inflation has moved into the Bank of Canada 1%-to-3% target band and only the second time to breach that band since March 2021.

Grocery price inflation also decelerated broadly in January to 3.4% y/y, down from 4.7% in December. Lower prices for airfares and travel tours also contributed to the headline deceleration. Prices for clothing and footwear were 1.3% lower than levels from a year ago, potentially reflecting the discounting of winter clothing after a milder-than-usual winter in much of the country.

The shelter component of inflation remains by far the largest contributor to annual inflation. The effect of past central bank rate hikes feeds into the CPI with a lag. The y/y growth in mortgage interest costs edged lower in January but still posted a 27.4% rise and accounted for about a quarter of the total annual inflation. Inflation, excluding mortgage costs, is now at 2.0%. Home rent prices continue to rise, but another component under shelter – homeowners’ replacement costs inched lower on slower house price growth.

On a monthly basis, the CPI was unchanged in January, following a 0.3% decline in December. On a seasonally adjusted monthly basis, the CPI fell 0.1% in January, the first decline since May 2020.
The Bank of Canada’s preferred core inflation measures, the trim and median core rates, exclude the more volatile price movements to assess the level of underlying inflation. The CPI trim slowed three ticks to 3.4%, and the median declined two ticks to 3.3% from year-ago levels, as shown in the chart below.

Notably, the share of the CPI basket of goods and services growing at more than 5% has declined from the peak of 68% in May 2022 to 28% in January 2024.
Bottom Line

The next meeting of the Bank of Canada Governing Council is on March 6. While January’s inflation report was better than expected and shows that the breadth of inflation is narrowing, it is still well above the level consistent with the 2% inflation target.

Shelter inflation will remain sticky as higher mortgage rates over the course of last year filter into the index and the acute housing shortage boosts rents.

The Bank of Canada will remain cautious in the face of still-high wage gains and core inflation measures above 3%. I hold to my view that the Bank will begin cutting rates in June.
Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

The Bank of Canada Held Rates Steady and Took A More Neutral Tone

Latest News Leslie Blais 7 Dec

It was widely expected that the Bank of Canada would maintain its key policy rate at 5% for the third consecutive time. It will continue to sell government securities (quantitative tightening) to normalize its balance sheet. Market participants weighed and measured each word of the BoC press release and assessed that the Bank took a less hawkish stance.

This time, the release said, “Higher interest rates are clearly restraining spending: consumption growth in the last two quarters was close to zero, and business investment has been volatile but essentially flat over the past year. Exports and inventory adjustment subtracted from GDP growth in the third quarter, while government spending and new home construction provided a boost. The labour market continues to ease: job creation has been slower than labour force growth, job vacancies have declined further, and the unemployment rate has risen modestly. Even so, wages are still rising by 4-5%. Overall, these data and indicators for the fourth quarter suggest the economy is no longer in excess demand.”

At the prior meeting in late October, the Bank said that the labour market remained “on the tight side” but acknowledged today that it was loosening. Indeed, the October Monetary Policy Report suggested that the inflation rate would not hit its 2% target level until late 2025.

 

Today, the tone was much more optimistic, suggesting that policymakers are increasingly confident interest rates are restrictive enough to bring inflation back to the 2% target. Still, Bank officials want to see more progress on core inflation before it begins to ease. It said, “The Bank’s preferred measures of core inflation have been around 3½-4%, with the October data coming in towards the lower end of this range.”

The central bank focuses on “the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour” and remains resolute in restoring price stability.

Bottom Line

Bond yields peaked in early October and have fallen by nearly 100 basis points. This has led to reductions in fixed mortgage rates; however, those cuts have been far less than historical experience would have suggested, given the rally in 5-year government bonds.

Cuts in variable mortgage rates await a reduction in the overnight policy rate, which triggers a commensurate decline in the prime rate, which is currently stuck at 7.2%. I expect the BoC to begin cutting the policy rate by the middle of next year, taking it down a full percentage point to 4% by yearend.

 

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres
drsherrycooper@dominionlending.ca

May Inflation Numbers Were Good, But Will They Satisfy the Bank of Canada?.

Latest News Leslie Blais 28 Jun

will the may inflation decline thwart another rate hike in july?

The May inflation data, released this morning by Statistics Canada, bore no surprises. The year-over-year (y/y) inflation measured by the Consumer Price Index (CPI) at 3.4% was just as expected–down a full percentage point from the April reading. This is the smallest increase since June 2021. Economists hit this one on the head because we knew dropping the April 2022 figure from the y/y calculation would considerably lower May inflation.

By May of last year, y/y  inflation had already risen sharply to 7.7%, mainly due to dramatic energy price increases reflecting the impact of the Russian invasion of Ukraine. Inflation peaked at 8.1% in June ’22, suggesting low inflation next month as well. This is why the Bank of Canada predicted that inflation would fall to 3% by this summer.

Taking inflation down to 3% will likely be easier than the drop from 3% to 2% because the low-hanging fruit has already been harvested. Many service prices are a lot stickier than the price of commodities and durable goods.

The May inflation slowdown was primarily driven by the 18.3% y/y plunge in gasoline prices resulting from the base-year effect. Excluding gasoline, the CPI rose 4.4% in May, following a 4.9% increase in April. A drop in natural gas prices (-3.5%) also contributed to the energy price deceleration.

Prices for durable goods grew at a slower pace year over year in May, rising 1.0% after increasing 2.2% in April. The increase in May is the smallest since May 2020 and coincided with easing supply chain pressures compared with a year ago. This was reflected in furniture prices (-2.9%), which fell by the largest amount since June 2020, and passenger vehicle prices (+3.2%), which showed the smallest increase since February 2021.

 

Grocery prices remain elevated–up 9.0% y/y–down only one tick from April. Prices for food purchased from restaurants rose slightly faster year-over-year in May (+6.8%) than in April (+6.4%), amid ongoing elevated labour shortages, input costs and expenses, which Stats Can data show job vacancies can disproportionately affect these businesses.

Rising interest rates also boost inflation. This is because mortgage costs are just over 3% of the CPI. They are a part of the most significant component of the index–shelter–which represents almost 30% of the index. The mortgage interest cost index rose by a whopping 29.9% in May, following a 28.5% increase in April. This was the largest increase on record for the third consecutive month, as Canadians continued to renew and initiate mortgages at higher interest rates. And, of course, this does not include the effects of the policy rate hike in June.

It takes time for the full effect of interest rate hikes entirely feed into the CPI. Mortgage interest costs will continue to rise as higher interest rates flow gradually through to household mortgage payments with a lag as contracts are renewed. And home-buying related expenses ticked higher in May, with higher home resale prices increasing realtor and broker commissions.

 

Bottom Line

Achieving the 2% inflation target will take some effort. The Bank of Canada continues to be concerned that the Canadian economy remains too hot. Although unemployment relative to job vacancies has recently started to rise, the Bank remains troubled that excess demand will continue to push some prices upward. This is the cyclical component of inflation–inversely correlated with the unemployment rate–a version the Fed calls ‘supercore’ inflation. Supercore includes household services such as haircuts, personal care, babysitting, restaurant meals, travel, accommodation, recreation and entertainment.

It is roughly the CPI-trim (which filters out extreme price movements that might be caused by severe weather and other temporary factors) minus the price of food, shelter and energy. This measure has fallen less than the other core measures. Supercore inflation is about 5.5% y/y, compared to CPI-trim at 3.8%,CPI- median at 3.9% (see the chart below).

Looking at the recent monthly trends on a three-month annualized basis, CPI-trim was at 3.8% in May, down from 3.9%, and CPI-median was at 3.6%, down from 3.8% in April.

This is why the Bank of Canada emphasizes labour market data and overall spending measures. We will get two more important Statistics Canada releases before the July 12th BoC decision: the June 30th  monthly GDP number for April and the all-important Labour Force Survey on July 7th. Unless these data show a meaningful economic slowdown or a rise in unemployment, the odds of another BoC rate hike are about 60%.

 

Please Note: The source of this article is from SherryCooper.com/category/articles/
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