No Surprises Here: The Bank of Canada Hiked Rates By Only 25 bps, Signalling a Pause

As expected, the Bank of Canada–satisfied with the sharp decline in recent inflation pressure–raised the policy rate by only 25 bps to 4.5%. Forecasting that inflation will return to roughly 3.0% later this year and to the target of 2% in 2024 is subject to considerable uncertainty.

The Bank acknowledges that recent economic growth in Canada has been stronger than expected, and the economy remains in excess demand. Labour markets are still tight, and the unemployment rate is at historic lows. “However, there is growing evidence that restrictive monetary policy is slowing activity, especially household spending. Consumption growth has moderated from the first half of 2022 and housing market activity has declined substantially. As the effects of interest rate increases continue to work through the economy, spending on consumer services and business investment is expected to slow. Meanwhile, weaker foreign demand will likely weigh on exports. This overall slowdown in activity will allow supply to catch up with demand.”

The report says, “Canada’s economy grew by 3.6% in 2022, slightly stronger than was projected in October. Growth is expected to stall through the middle of 2023, picking up later in the year. The Bank expects GDP growth of about 1% in 2023 and about 2% in 2024, little changed from the October outlook. This is consistent with the Bank’s expectation of a soft landing in the economy. Inflation has declined from 8.1% in June to 6.3% in December, reflecting lower gasoline prices and, more recently, moderating prices for durable goods.”

Short-term inflation expectations remain elevated. Year-over-year measures of core inflation are still around 5%, but 3-month measures of core inflation have come down, suggesting that core inflation has peaked.

The BoC says, “Inflation is projected to come down significantly this year. Lower energy prices, improvements in global supply conditions, and the effects of higher interest rates on demand are expected to bring CPI inflation down to around 3% in the middle of this year and back to the 2% target in 2024.” (the emphasis is mine.)

The Bank will continue its policy of quantitative tightening, another restrictive measure. The Governing Council expects to hold the policy rate at 4.5% while it assesses the cumulative impact of the eight rate hikes in the past year. They then say, “Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target, and remains resolute in its commitment to restoring price stability for Canadians.”

Bottom Line

The Bank of Canada was the first major central bank to tighten this cycle, and now it is the first to announce a pause and assert they expect inflation to fall to 3% by mid-year and 2% in 2024.

No rate hike is likely on March 8 or April 12. This may lead many to believe that rates have peaked so buyers might tiptoe back into the housing market. This is not what the Bank of Canada would like to see. Hence OSFI might tighten the regulatory screws a bit when the April 14 comment period is over.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Good News on the Inflation Front in December

The Consumer Price Index (CPI) rose 6.3% year over year in December, down from the 6.8% pace in November. Much of the decline was owing to the drop in gasoline prices. Additional deceleration came from homeowners’ replacement costs, fuel oil and other owned accommodation expenses, and various durable goods. Slower price growth was offset by increases in mortgage interest cost, clothing and footwear and personal care supplies and equipment.

Excluding food and energy, prices rose 5.3% yearly last month, down only 0.1% from a gain of 5.4% in November.

The global slowdown and surging COVID cases in China contributed to the decline in crude oil prices, depressing the price of gasoline and fuel oil.

Easing supply chain pressures, lower shipping costs, and softer demand contributed to the slowdown in the price inflation for appliances and furniture.

For the third month in a row, yearly price growth slowed for passenger vehicles (+7.2%), which may reflect slowing demand for used cars.

On a year-over-year basis, homeowners’ replacement cost (+4.7%) and other owned accommodation expenses (+2.5%) continued to slow as the housing market continued to cool, putting downward pressure on the CPI.

The mortgage interest cost index continued to put upward pressure on the CPI amid the ongoing higher interest rate environment, rising 18.0% yearly in December following a 14.5% increase in November.

Food price inflation remained high last month at 11% compared to 11.4% in November. Food price growth has hovered around 11% over the previous five months.

The core CPI metrics slowed (see chart below), but only inappreciably. Two key yearly measures tracked closely by the central bank — the so-called trim and median core rates — edged lower, averaging 5.15% from an upwardly revised 5.25% a month earlier. Economists were expecting a reading of 5.05%.

One significant concern of the Bank of Canada is inflation expectations that cause workers to demand higher wages and businesses to pass through higher costs on to the consumer. The Bank’s latest surveys show that consumer and business expectations of inflation remain elevated.

According to the Bank’s consumer survey, “Yet consumers are still concerned about inflation, and some are uncertain about the effectiveness of tightening monetary policy. More than three-quarters of people understand that the Bank aims to reduce inflation by raising interest rates. But the share of those who believe that increasing rates will lead to lower inflation remains small at around two-fifths of respondents.”  Consumers appear to believe that inflation will be at just over 5% two years from now, well above the 2% target.

Bottom Line

The dramatic monetary tightening in the past nine months has slowed headline inflation. The decline in December, however, was primarily due to seasonality and a significant drop in gasoline prices. Core inflation eased only marginally. Underlying price pressures remain sticky. The Bank of Canada will likely hike rates by another 25 bps at next week’s meeting. Beyond that, the Bank might pause, at least for a while, depending on the incoming data.

It won’t surprise me if they resume their tightening later this year. I do not expect any rate reductions in 2023.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

December Housing Data Ended 2022 On A Weak Note

Statistics released today by the Canadian Real Estate Association (CREA) show national home sales were up month-over-month in December while new listings plummeted and national home prices fell again.

Home sales recorded over Canadian MLS® Systems increased 1.3% between November and December 2022. Ottawa and Edmonton led gains. Nevertheless, the actual number of transactions last month was 39.1% below year-ago levels and dramatically below the 10-year monthly moving average for December (see chart below).

New Listings

Sellers remained on the sidelines. The number of newly listed homes dropped 6.4% month-over-month in December, led by British Columbia and Quebec declines. It was among the lowest December new supply levels on record.

With new listings down by quite a bit more than sales on a month-over-month basis, the sales-to-new listings ratio tightened to 54.4% compared to 50.2% posted in November. The long-term average for this measure is 55.1%.

There were 4.2 months of inventory on a national basis at the end of December 2022. This is close to where this measure was in the months leading up to the initial COVID-19 lockdowns and still nearly a full month below its long-term average.

Home Prices

Canadian home prices fell by the most on record in 2022 as rapidly rising interest rates forced a market adjustment that may not yet be over. The country’s benchmark home price fell 1.6% in December to C$730,600, bringing the total decrease since March to 16.4%. Last year also saw the most significant price decline for a calendar year since records began, with a 7.5% drop overall.

The Aggregate Composite MLS® HPI, which adjusts for the type of property sold, now sits about 13% below its peak level. Looking across the country, prices are down more than they are nationally in Ontario and parts of B.C. and down by less elsewhere. While prices have softened to some degree almost everywhere, Calgary, Regina, Saskatoon, and St. John’s stand out as markets where home prices are barely off their peaks at all.

The non-seasonally adjusted Aggregate Composite MLS® HPI was 7.5% below its December 2021 reading.

The table below shows the decline in MLS-HPI benchmark home prices in Canada and selected cities since prices peaked in March when the Bank of Canada began hiking interest rates. More details follow in the second table below. The most significant price dips are in the GTA and the GVA, where the price gains were spectacular during the Covid-shutdown.

Even with these large declines, prices remain roughly 33% above pre-pandemic levels.

Bottom Line

Tomorrow, we will see the release of the Canadian CPI data for December. I expect a continued improvement in the headline and core inflation rates. Even so, the odds favour a 25 bps hike in the overnight policy rate next week when the Bank of Canada announces its decision. Labour data for December remained strong; the economy has shown continued resilience, and today’s Business Outlook Survey deteriorated further in the fourth quarter.

Inflation expectations remain elevated as the share of firms expecting inflation to be above 3% over the next year hit a new record high of 84%. Almost 40% of respondents expect inflation to persist well above 2% into 2026 and beyond, reflecting perceived stickiness in energy prices, supply chain issues, strong demand, and labour costs, as well as the time it takes for monetary policy to slow inflation.

In a separate release, the BoC’s Survey of Consumer Expectations showed that consumers feel the pinch of reduced purchasing power and increasing wage demands. One-year-ahead inflation expectations remained elevated at over 7%, though expectations moderated at longer time horizons.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Employment Report Ended 2022 With A Boom

Today’s Labour Force Survey for December was much stronger than expected, raising the odds of a 25 bps increase in the policy rate by the Bank of Canada on January 25th. While the Bank has hiked rates by 400 bps to 4.25%, core inflation remains sticky, wages have risen by more than 5% for the seventh consecutive month in December, and Q4 GDP is running well above the Bank’s forecast of 0.5%.

Employment rose by 104,000 last month, and the unemployment rate fell to 5.0%–just above the 50-year low of 4.9% posted in June and July. Indeed, the jobless rate would have fallen even further had the labour force participation rate not ticked upward as discouraged workers re-enter the jobs market when vacancies are plentiful. Employment rose the most for youth and people aged 55 and older.

Throughout 2022 the employment rate of core-aged women hovered around record highs. On average, 81.0% of core-aged women were employed, the highest annual rate since 1976 and 1.3 percentage points higher than in 2019.

Much of this increase has been among women with young children. On average, during 2022, 75.2% of core-aged women with at least one child under six years of age were working at a job or business, up 3.3 percentage points compared with 2019.

The increase in employment in December was driven by full-time work, which rose for a third consecutive month.  Full-time work also led employment growth for the year ending in December 2022.

Employment rose in multiple industries, notably construction, transportation, and warehousing.

Job gains were reported in Ontario, Alberta, BC, Manitoba, Newfoundland and Labrador, and Saskatchewan.  There was little change in the other provinces.

Bottom Line

The Canadian economy has also been boosted by strength in the US, where nonfarm payroll employment rose by 223,000 in December, and the unemployment rate fell to 3.5%, matching a five-decade low.

Governor Tiff Macklem and his officials have slowed down the rate hikes (from 75 bps to 50 bps) and signalled that future decisions would depend on economic data. Indeed, the most recent GDP and today’s jobs report point to continued economic strength. The October and November gains in GDP suggest Canada’s growth is holding up better than expected. The economy is on track to expand at an annualized rate of 1.2% in the fourth quarter, exceeding the central bank’s expectations.

The December CPI report will be released on Jan 17, ahead of the Jan 25 Bank of Canada decision. That will be closely watched as well.

In other news, housing market activity continued to slow in December. Home sales plummeted in the country’s largest metro areas by 30%-to-50% as buyers and sellers moved to the sidelines. Housing is the most interest-sensitive sector and has been slowing since the Bank began hiking interest rates last March.

Greater Vancouver led the way, with sales falling 52% year-over-year, while the Greater Toronto Area saw a 48% decline. Montreal followed with a 39% annual decline, whereas sales were down 30% in both Calgary and Ottawa.

Average prices continued to fall in most of the metro areas. The MLS Home Price Index benchmark is now down 9% year-over-year in the Greater Toronto Area. In Calgary, however, average prices remain nearly 8% above year-ago levels.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres