Commentaries Topics: Bank of Canada

While the Bank held its fire, we should consider this a “hawkish hold,” emphasizing that it will raise interest rates further, if needed. Even though underlying inflation pressures remain problematic, the abrupt and unexpected contraction in Canada’s economy in the second quarter is for now overshadowing inflation concerns. Leading indicators suggests we could be heading into a mild recession, if we aren’t already there.

Stephen Tapp, Chief Economist, Canadian Chamber of Commerce

KEY TAKEAWAYS

• After two consecutive rate increases over the summer, today the Bank of Canada held its policy rate at 5.0% and continued quantitative tightening, by allowing maturing assets to roll off its balance sheet. These moves were widely expected by financial markets after last Friday’s disappointing data, which showed a surprising contraction in Canada’s GDP in the second quarter (-0.2% annualized, which included downward revisions to previous data, and was well below the +1.2% growth expected).
• As our Local Spending Tracker indicated earlier, consumer spending is finally slowing in response to higher rates. For the overall economy, fast growth in population and prices have flattered headline nominal numbers, but digging into the real numbers reveals a much weaker story: official data now show Canada’s inflation-adjusted household spending per person fell in three of the last four quarters. Real GDP per capita and productivity data have also brought serial disappointments.
• The labour market has also softened with falling labour demand showing up in lower job vacancies. The unemployment rate has recently crept up 0.5 percentage points—which is close to crossing a threshold that often signals a recession is underway. That said, wage growth remains elevated at between 4% and 5%. Given weak labour productivity, this is above the level that’s consistent with the 2% inflation target.
• Inflation remains broad-based and running too hot at around 3.5% annualized. It is still uncomfortably above the top of the Bank of Canada’s inflation control target, both on a year-over-year basis and in shorter-term “core” measures. The Bank emphasized that, “the longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability.”
• In the last announcement, Governing Council said it was looking for progress on: short-run core inflation; wages; corporate pricing behaviour; and inflation expectations. Unfortunately, all these signs remain problematic. However, the abrupt slowdown in Canada’s economy is overshadowing these concerns and suggests we could be heading into a mild recession, if we aren’t already there.
• Overall, the Bank delivered a “hawkish hold”, as expected, stating that “Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed.”
• We will have to wait until October 25^th for the Bank’s next Monetary Policy Report with updated economic projections. Right now, we could be headed for mild “stagflation”, which would be difficult for the BoC, featuring slow or stagnant economic growth, but stubborn inflation that’s slow to return to the 2% target.

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KEY TAKEAWAYS

• The Bank of Canada raised its policy rate by 25 basis points for the second consecutive meeting. It now sits at 5.0%, the highest rate since 2001, as the central bank tries to wrestle inflation back to target. This move was no surprise: most forecasters expected it; and financial markets largely priced it in beforehand (giving it about a 70% chance). The Bank is continuing quantitative tightening, as assets roll off its balance sheet.
• Stronger-than-expected U.S. economy, more global price pressure: The Bank revised up its near-term outlook for the global economy, led by the U.S., reflecting “surprisingly robust” consumer spending. Despite the slowdown in headline inflation, core inflation pressures — especially for services — remain stubbornly high across many economies, and other central banks are expected to raise rates further.
• Canada holding up better-than-expected: The Bank also revised up its outlook for Canada’s GDP growth this year, citing more persistent excess demand. continued tightness in the labour market, the upturn in housing, and strong population growth coming from immigration. That said, Canada’s growth is expected to be below trend, averaging only 1% over the next 12 months, as the economy adjusts to the lagged effects of higher interest rates. This still represents a “soft landing”, which is more optimistic than expected by most Canadian forecasters.
• Inflation proving more persistent: Canada’s headline inflation slowed to 3.4% in May. However much of this progress is from lower energy prices relative to a year ago. With these “base-year effects” dropping out of future year-over-year calculations, disinflation progress will slow. Indeed, short-run core inflation (3-month annualized rates that remove volatile components, and are a key metric for the Bank) has been running between 3.5% and 4% since last September, raising concerns that progress has stalled.
• The Bank now expects headline CPI inflation to stay around 3% for the next year, before declining gradually to the 2% target by mid-2025, which is six months later than in the last projection.
• Possibly the end of the road: Looking ahead, Governing Council will be looking for more progress on: short-run core inflation dynamics; wages; normalized corporate pricing behaviour; and anchoring of inflation expectations across the economy. All of these signs remain problematic for now. Financial markets are pricing in a roughly 1-in-3 chance of another rate hike in September. If the key metrics above show continued progress, then today’s move to 5% will likely mark the end of this tightening cycle. But there’s little doubt that central banks across advanced economies will continue to tighten financial conditions. And further hikes in Canada will stay on the table, until the Bank is satisfied that inflation will safely return to 2%.

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Today, the Bank of Canada increased interest rates once again, after taking a short pause of only a few months. The increase of 25 basis points takes the overnight rate to 4.75%. After two stronger-than-expected reports – by way of April’s inflation increase and Q1 2023’s GDP growth – this decision is not shocking but was not expected until July when the Bank issues its next Monetary Policy Report. As the cumulative impact of past rate hikes continue to slow demand and inflation, this decision is proof that the Bank is resolute in its determination to return inflation to the 2% target

Marwa Abdou, Senior Research Director, Canadian Chamber of Commerce

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The Bank of Canada held its policy rate at 4.5% and renewed its commitment to bringing inflation back to the 2% target. Though inflation is declining, it remains well above target, and the economy is in excess demand. The Bank expects Canada’s GDP growth to remain weak in 2023, but is no longer forecasting a recession in Canada.

Mahmoud Khairy, Economist, Canadian Chamber of Commerce

KEY TAKEAWAYS

• The Bank of Canada held its policy rate: As expected, the Bank held its policy rate at 4.5%. This was the second consecutive hold during their “conditional pause” period (after previously hiking rates by a cumulative 4.25%). The Bank is also continuing its quantitative tightening policy.
• Global economic outlook better than expected in 2023: Despite tighter monetary policy and banking sector stress in the U.S. and Europe, global economic data have been better than the Bank previously anticipated. The Bank, therefore, revised up its projection for world economic growth (to 2.6% from 1.9%), while revising down 2024 slightly (to 2.1% from 2.4%). That said, the U.S. economy is expected to be weaking in the coming quarters, mainly due to slower consumer spending and tightener credit condition.
• Canada’s economy to grow modestly in 2023: Economic activity clearly slowed down over 2022, but the Bank still sees Canada’s economy as being in a position of “excess demand”. The good news is that with the bounce-back now expected for 2023Q1, the Bank is no longer forecasting a recession in Canada in 2023, and revised up its growth outlook from 1.0% to 1.4%.
• Inflation progress, but job not done: Inflation has declined from its peak of 8.1% last summer to 5.2% most recently. The Bank will be encouraged by this progress and expects inflation to slow to 3% this summer, but the return to 2% could take longer than previously expected — now near the end of 2024.
• The slowdown in inflation so far is largely due to falling prices for energy and other goods. Services prices have only really stabilized and will need to come down further for inflation to return to target. Food inflation remains high, and with a tight labour market, wages are growing at 4-5%, and may only ease slowly with continued labour supply growth.
• The Bank highlighted five key progress indicators that it will be watching: inflation expectations, services inflation, wages, business pricing behavior, and core inflation. Governing Council reiterated that it, “remains prepared to raise the policy rate further if needed” to get inflation back to target. This should send a clearer message to financial markets that they shouldn’t expect the Bank rate to fall in 2023, as was previously priced in.

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Key Takeaways

• Today, the Bank of Canada raised its policy interest rate by 50 bps to 4.25%. This decision was a close call. Financial market participants were essentially split on whether the Bank would deliver another 50-basis point hike or drop down to 25 basis points.
• Ultimately, the Bank decided to remain hawkish because:
  1. Headline inflation in Canada is still far too high (6.9% year-over-year in October). Inflation remains broad-based across many frequently purchased goods and services, which makes it highly visible for everyday Canadians.
  2. Inflation expectations are elevated. In the Bank’s latest consumer and business surveys, most respondents expected inflation to remain above the top of the Bank’s inflation control band for the next two years. As the Bank notes, “The longer that consumers and businesses expect inflation to be above the target, the greater the risk that elevated inflation becomes entrenched.”
  3. Core inflation — which tries to measure underlying price pressure — is running above 5% on a year-over-year basis, even if the Bank is focused on more forward-looking, shorter-term core inflation measures, rather than the backward-looking year-over-year rate. The Bank’s shorter-term 3-month annualized core rates slowed to around 3.4% in October, which is a positive sign and suggests price pressures are losing momentum as the global economy slows. However, even if this slower recent core rate was maintained, inflation would remain above the top of the Bank’s target at the end of 2023.
• Terminal rate? By choosing a stronger move today, the Bank’s statement signals they are willing to pause their rate tightening cycle for now to assess the impact that their sharp rise in interest rates is having on the Canadian economy. Rate hikes made earlier in 2022 will continue to slow demand into 2023. Housing markets continue to correct, and final domestic demand fell in the third quarter. The Bank continues to expect economic growth in Canada to stall during 2022Q4 to 2023Q2.

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My Twitter followers narrowly made the right call.

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