Hawkish Hold By The Bank of Canada

The Bank of Canada today held its target for the overnight rate at 5%, as was widely expected. The central bank continues to normalize its balance sheet through quantitative tightening, reducing its Government of Canada bonds holdings.

The Monetary Policy Report (MPR) detailed a slowdown in global economic growth “as past increases in policy rates and the recent surge in global bond yields weigh on demand.” Continued increases in longer-date bond yields reflect the stronger-than-expected growth in the US, where the Q3 economic growth rate, released tomorrow, is expected to be a whopping 5%. Ten-year yields in the US have risen to nearly 5%, boosting fixed mortgage rates in Canada.

Oil prices are higher than was assumed in the July MPR, and the war in Israel and Gaza is a new source of geopolitical uncertainty.

The Governing Council said that past increases in interest rates are slowing economic activity in Canada and relieving price pressures. “Consumption has been subdued, with softer demand for housing, durable goods and many services. Weaker demand and higher borrowing costs are weighing on business investment. The surge in Canada’s population is easing labour market pressures in some sectors while adding to housing demand and consumption. In the labour market, recent job gains have been below labour force growth, and job vacancies have continued to ease. However, the labour market remains on the tight side, and wage pressures persist. Overall, a range of indicators suggest that supply and demand in the economy are now approaching balance.”

Economic growth in Canada averaged 1% over the past year, and the Bank forecasts it will continue to be weak for the next year before increasing in late 2024 and through 2025. The Bank is not forecasting a recession over this period. “The near-term weakness in growth reflects both the broadening impact of past increases in interest rates and slower foreign demand. The subsequent pickup is driven by household spending as well as stronger exports and business investment in response to improving foreign demand. Spending by governments contributes materially to growth over the forecast horizon. Overall, the Bank expects the Canadian economy to grow by 1.2% this year, 0.9% in 2024 and 2.5% in 2025.”

The central bank highlighted the volatility of CPI inflation in recent months–at 2.8% in June,k 4.0% in August and 3.8% in September. “Higher interest rates are moderating inflation in many goods that people buy on credit, and this is spreading to services. Food inflation is easing from very high rates. However, in addition to elevated mortgage interest costs, inflation in rent and other housing costs remains high. Near-term inflation expectations and corporate pricing behaviour are normalizing only gradually, and wages are still growing around 4% to 5%. The Bank’s preferred measures of core inflation show little downward momentum.”

In today’s MPR, CPI is expected to average about 3.5% through the middle of next year before gradually falling to the 2% target level in 2025. “Inflation returns to target about the same time as in the July projection, but the near-term path is higher because of energy prices and ongoing persistence in core inflation.”

The hawkish tone of the final paragraph of today’s press release is noteworthy. The Bank does not want to boost interest-sensitive spending, such as housing and durable goods purchases, by assuring markets that its next move will be a rate cut. Instead, the Bank said, “Governing Council is concerned that progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed. The Governing Council wants to see downward momentum in core inflation. It continues to be focused on the balance between demand and supply in the economy, inflation expectations, wage growth and corporate pricing behaviour. The Bank remains resolute in its commitment to restoring price stability for Canadians.”

Bottom Line

Nothing was surprising in today’s report. The slowdown in economic activity since late last year has dramatically reduced excess demand. The output gap–the difference between the actual growth in GDP and its potential growth at full employment–is essentially closed, suggesting that demand pressures have been easing. They had previously expected the output gap to close in early 2024.

Of concern to the Bank is that inflation remains above their 2% target in the face of increased global risks of higher inflation. Upside risks to inflation include elevated inflation expectations of households and businesses, growing extreme weather events, and heightened geopolitical uncertainties including the Israel-Hamas war.

Price gains in energy and shelter — upward pressures on inflation — are “anticipated to be partially offset by the easing of excess demand, weaker pressure from input costs and further disinflation in globally traded goods,” the Bank said.

“Ongoing excess supply in the economy moderates price inflation, helps ease inflation expectations and encourages businesses to gradually return to more normal pricing behaviour.”

Canada’s households are more indebted, on average, than their US counterparts and their shorter-duration mortgages roll over faster. That makes the Canadian economy more sensitive to higher rates and is one reason the Bank of Canada first declared a pause in January, well before the US Federal Reserve. The central bank’s next decision is due Dec. 6, after two releases of jobs data, October inflation numbers and third-quarter gross domestic product figures. I expect the Bank to pause rate hikes for the next six to nine months. When they finally begin to ease monetary policy, they will do so gradually, taking the overnight rate down to roughly 4% by the end of next year.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Good News On the Inflation Front Suggests Policy Rates Have Peaked

Today’s inflation report for September was considerably better than expected, ending the three-month rise in inflation. Not only did the headline inflation rate fall, but so did the core measures of inflation on a year-over-year basis and a three-month moving average basis. This, in combination with the weak Business Outlook Survey released yesterday, suggests that the overnight policy rate at 5% may be the peak in rates. While I do not expect the Bank to begin cutting rates until the middle of next year, the worst of the tightening cycle may well be over.

Offsetting the deceleration in the all-items CPI was a year-over-year increase in gasoline prices, which rose faster in September (+7.5%) compared with August (+0.8%) due to a base-year effect. Excluding gasoline, the CPI rose 3.7% in September, following a 4.1% increase in August. Looking ahead to the October inflation report, the base effect for headline CPI is favourable, as CPI surged in October 2022. Gasoline prices are down about 7% so far this month. Given the war in the Middle East, however, there is no guarantee that this will hold, but if it does, the October headline CPI could move into the low-3% range.

On a monthly basis, the CPI fell 0.1% in September after a 0.4% gain in August. The monthly slowdown was mainly driven by lower month-over-month prices for gasoline (-1.3%) in September. Goods inflation fell 0.3% from a month earlier, the first time since December 2022, and grew 3.6% from a year ago versus 3.7% in August. Services inflation was unchanged from August, the first time it hasn’t grown on a monthly basis since November 2021, while the rate slowed to 3.9% on a yearly basis, from 4.3% in August.

Yesterday’s Survey of Consumer Expectations showed that perceptions of current inflation remain well above actual inflation.  One reason is the very visible level of grocery and gasoline prices. As the chart below shows, food inflation–though still elevated–decelerated to 5.9% last month, and CPI excluding food and energy fell to a cycle-low 2.8%. Large monthly gains in September 2022, when grocery prices increased at the fastest pace in 41 years, fell out of the 12-month movements and put downward pressure on the indexes.

Prices for durable goods rose at a slower pace year over year in September (+0.4%) compared with August (+1.4%). The purchase of new passenger vehicles index contributed the most to the slowdown, rising 1.7% year over year in September, following a 3.1% gain in August. The deceleration in the price of new passenger vehicles was partly attributable to improved inventory levels compared with a year ago.

Additionally, furniture prices (-4.6%) and household appliances (-2.3%) continued to decline year-over-year in September, contributing to the slowdown in durable goods. Consumers paid less on a year-over-year basis for air transportation (-21.1 %) in September, coinciding with a gradual increase in airline flights over the previous 12 months.

Other measures of core inflation followed by the Bank of Canada also decelerated.

Bottom Line

According to Bloomberg News calculations, “A three-month moving average of underlying price pressures that Governor Tiff Macklem has flagged as key to policymakers’ thinking fell to an annualized pace of 3.67%, from 4.29% a month earlier.”  While this is still well above the Bank’s 2% target, the global economy is slowing, the Canadian and US economies are slowing, and with any luck at all, the Bank of Canada might see inflation move to within its target range next year. However, the central bank will be cautious, refraining from rate cuts until the middle of next year. The full impact of rate hikes has yet to be felt. The next move by the Bank of Canada could be a rate cut, but not until next year.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Increasing Mortgage Rates Weighed Heavily On Housing In September

Mortgage rates continued to rise in September after BoC tightening and one of the largest bond selloffs in history. Yields have retraced some of their rise more recently, but demand for new and existing homes has slowed. According to data released by the Canadian Real Estate Association, national home sales declined 1.9% m/m in September, its third consecutive monthly decline. At least September’s drop was about half as large as in August, dominated by weakness in the Greater Vancouver and the Greater Toronto Area. Sales gains were posted in Edmonton, Montreal and the Kitchener-Waterloo region.

The actual (not seasonally adjusted) number of transactions in September 2023 came in 1.9% above September 2022, but that was far less than the growth in the Canadian population over that period.

The CREA updated its forecast for home sales activity and average home prices for the remainder of this year and next. They commented that the national sales-to-new listings ratio has fallen from nearly 70% to 50% in the past five months, slowing the price rally in April and May. The CREA has cut its forecast for sales and prices, reflecting the marked slowdown in Ontario and BC. The expected rebound in activity next year has also been muted as interest rates remain higher for longer than initially expected.

New Listings

The big news in this report was the surge in new listings as sellers finally come off the sidelines. The number of newly listed homes climbed 6.3% m/m in September, posting a 35% cumulative increase from a twenty-year low since March. New listings are trending near average levels now.

With sales continuing to trend lower and new listings posting another sizeable gain in September, the national sales-to-new listings ratio eased to 51.4% compared to 55.7% in August and a recent peak of 67.8% in April. It was the first time that this measure has fallen below its long-term average of 55.2% since January.

There were 3.7 months of inventory nationally at the end of September 2023, up from 3.5 months in August and its recent low of 3.1 months in June. That said, it remains below levels recorded through the second half of 2022 and well below its long-term average of about five months.

Home Prices

The Aggregate Composite MLS® Home Price Index (HPI) edged down 0.3% m/m in September 2023— the first decline since March.

That said, the slight dip in prices at the national level in September was entirely the result of trends in Ontario. Prices are still rising across other provinces, albeit more slowly than they were.
Incoming data over the next few months will determine whether Ontario is an outlier or just the first province to show the softening price trends expected to play out in at least some other parts of the country, given where interest rates are.

The Aggregate Composite MLS® HPI was up 1.1% y/y. While prices have generally been leveling off in recent months and even dipped nationally and in Ontario in September, year-over-year comparisons will likely continue to rise slightly in the months ahead because of the base effect of declining prices in the second half of last year.

Bottom Line

The Bank of Canada policymakers are set to meet on October 25, weighing the strong wage growth and employment gains against next Tuesday’s September inflation report. The US inflation data, released this week, was only a touch higher than expected. The Canadian information will unlikely disrupt the central bank’s pause in rate hikes.

The unexpected Israeli war will disrupt the global economy again, which could cause supply chain concerns if it lasts long enough. Oil prices and technology (semiconductor chips and other tech-related products) could be impacted. With so much uncertainty and a marked third-quarter economic data slowdown, the BoC will likely remain on the sidelines.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres