Red Hot Labour Market Despite Rate Hikes

Today’s Labour Force Survey (LFS) for January was much stronger than expected, once again calling into question how long the Bank of Canada’s rate pause will last. This report showed no evidence that the labour market is slowing in response to the vast and rapid runup in interest rates.

Employment surged by 150,000–ten times more than expected–and most of the gain was in full-time jobs. The employment rate has returned to pre-pandemic levels. Employment rates among people 55 to 64 have been on a solid upward trend since the summer of 2022, mirroring the rise in employment over that period observed among most demographic groups.

Immigration remains a vital factor in hiring. According to the latest population estimates, in the third quarter of 2022, Canada’s population grew the fastest in over 50 years, mainly driven by an increase in non-permanent residents. In the Labour Force Survey, non-permanent residents represent the majority of a larger group, including those who were not born in Canada and have never been landed immigrants. Non-permanent residents can hold various kinds of work, study, or residence permits. On a year-over-year basis, employment for those not born in Canada and who have never been a landed immigrant was up 13.3% (+79,000) in January, compared with growth in total employment of 2.8% (+536,000).

Average hourly wages rose 4.5% on a year-over-year basis in January, down from 4.8% in December. This is good news for the inflation outlook, but it remains much above the 2% target. Year-over-year wage growth reached 5.0% in June 2022 and peaked at 5.8% in November (not seasonally adjusted).

The unemployment rate remained near a record low, holding steady at 5.0% in January, just shy of the record-low 4.9% in June and July last year.

Employment growth was most robust in wholesale and retail trade, healthcare, education, other services and construction.

Bottom Line

The Canadian jobs market is showing no signs of slowing. This has to make the Bank of Canada at least a bit nervous. The US jobs market data in January was also robust, and the Fed Chairman, Jay Powell, has assured markets that interest rates are likely to rise further.

This is the last jobs report before the Bank of Canada meets again on March 8. The CPI data for January will be released on February 21 and will be the primary factor determining Bank action. If inflation continues to decline, as expected, the rate pause will hold. If not…

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

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

The Bank of Canada Hiked Rates The Full 50 bps

The Governing Council of the Bank of Canada raised its target for the overnight policy rate by 50 basis points today to 4.25% and signalled that the Council would “consider whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target”. This is more dovish language than in earlier actions where they asserted that rates would need to rise further. Some have interpreted this new press release to imply that the Bank of Canada will now pause or pivot. I disagree.

I expect there will be additional rate hikes next year, but they will be more measured and not on every decision date. I also feel that the Bank will refrain from cutting the policy rate until 2024.

The Bank told us today that the “longer that consumers and businesses expect inflation to be above the target, the greater the risk that elevated inflation becomes entrenched”. CPI inflation remained at 6.9% in October, “with many of the goods and services Canadians regularly buy showing large price increases.

Measures of core inflation remain around 5%. Three-month rates of change in core inflation have come down, an early indicator that price pressures may be losing momentum. However, inflation is still too high, and short-term inflation expectations remain elevated”.

The economy remains in excess demand, and the labour market is very tight. The jobless rate in November fell to 5.1%, and job vacancies increased in September. Wage inflation came in at 5.6% y/y in November for the second consecutive month, marking six straight months of wage inflation above 5%. While headline and core inflation have moderated from their recent peaks, they exceed the 2% target by a large measure.

The Bank will monitor incoming data, especially regarding the overheated labour market where the jobless rate is at historic lows. Housing has slowed sharply in recent months, but as long as labour markets are tight, a slowdown in other sectors will be muted. The Bank now says it expects the economy “to stall” in the current quarter and the first half of next year.

Bottom Line

This will likely be the last oversized rate hike this cycle. The Governing Council next meets on January 25. Whether they raise rates will be data-dependent. If they do, it will likely be by 25 bps. Even if they pause at that meeting, it does not rule out additional moves later in the year if excess demand persists. I expect further monetary tightening, the continued bear market in equities, and a further correction in house prices.

Canadian benchmark home prices are already down nearly 10% nationwide. Several chartered banks told us this week that more than 25% of the remaining amortizations for their residential mortgages are 35 years and more. At renewal, these institutions expect to grant mortgages amortized at 25 years, which implies a substantial rise in monthly payments. That may well be three or four years away, but clearly, many households could be pinched unless mortgage rates plunge in the interim. I do not see the policy rate falling to its pre-COVID level of 1.75% over that period because inflation back then was less than 2%, an improbable circumstance as we advance. Although supply constraints may be easing, globalization has peaked. Semiconductors produced in the US will not be as cheap, and many rents, prices, and wages will be very sticky.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Bank of Canada Will Not Be Happy With This Inflation Report

Not only did the headline CPI inflation rate stall at 6.9% last month, but the core CPI numbers remain stubbornly high. Food inflation–a highly visible component–edged down slightly. Still, prices for food purchased from stores (+11.0%) continued to increase faster year over year than the all-items CPI for the eleventh consecutive month. Bonds fell on the news, with Canada’s two-year yield rising to 3.877% at 8:43 a.m. Ottawa time, about 3.5 basis points (bps) higher than its level before the data release. The yield on 5-year Government of Canada bonds spiked temporarily on the release of these disappointing inflation data. This was in direct contrast to the US, which posted a better-than-expected inflation reading for October last week.

Less than two weeks after a stronger-than-expected jobs report, the inflation numbers continue to show the economy in overheated territory. Bank of Canada Governor Tiff Macklem has said that rates will need to continue to rise further while acknowledging the end of this tightening cycle is near.

Traders are pricing at least a 25 basis-point increase at the next policy decision on Dec. 7, with a 50-50 chance of a half percentage point hike. The central bank has increased borrowing costs by 3.5 percentage points since March, bringing the benchmark overnight lending rate to 3.75%.

A significant factor in the Bank’s decision process is the continued rise in wage inflation to a 5.6% annual pace in October. If inflation expectations remain robust, wage-price spiralling becomes a real threat.

Bottom Line

Price pressures might have peaked, but today’s data release will not be welcome news for the Bank of Canada. There is no evidence that core inflation is moderating despite the housing and consumer spending slowdown. The average of the Bank’s favourite measure of core inflation remains stuck at 5.3%. The central bank slowed reduced its rate hike at the October 26th meeting to 50 bps, and while some traders are betting the hike in December will be 25 bps, there is at least an even chance that the Governing Council will opt for an overnight policy target of 4.25%.

Inflation is still way above the Bank’s 2%-target level. Ultimately, it will take a higher peak interest rate to break the back of inflation. I expect the policy target to peak at about 4.5% in early 2023 and to remain at that level for an extended period despite triggering a mild recession in early 2023.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Housing Correction Continued In October

Statistics released today by the Canadian Real Estate Association (CREA) show home sales were up 1.3% on a month-over-month basis in October. Still, monthly activity remained a whopping 36% below the October pace in 2021. The housing correction continues in response to the Bank of Canada’s massive rate hikes, but the speed of the correction is slowing.

“October provided another month’s worth of data suggesting the slow down in Canadian housing markets is winding up,” said Shaun Cathcart, CREA’s Senior Economist. “Sales actually popped up from September to October, and the decline in prices on a month-to-month basis got smaller for the fourth month in a row.”

You can see from the chart below just how slight the uptick in October home sales was, but at this stage, it shows that a housing crash is not occurring.

New Listings

The number of newly listed homes was up 2.2% on a month-over-month basis in October, with gains in the Greater Toronto Area (GTA) and the B.C. Lower Mainland offsetting declines in Montreal and Halifax-Dartmouth.

With sales up by a little less than new listings in October, the sales-to-new listings ratio fell to 51.6% compared to 52% in September. The long-term average for this measure is 55.1%.

There were 3.8 months of inventory on a national basis at the end of October 2022, up slightly from 3.7 months at the end of September. While the number of months of inventory is still well below the long-term average of about five months, it is also up quite a bit from the all-time low of 1.7 months set at the beginning of 2022.

Home Prices

The Aggregate Composite MLS® Home Price Index (HPI) edged down 1.2% month-over-month in October 2022, the smallest decline since June.

The national average transactions price fell 9.9% y/y  in October, while the MLS HPI dipped 0.8% y/y with downward momentum continuing on a month-to-month basis. The HPI is now down eight months or an even 10% from the February high. With mortgage rates across the spectrum pushing above 5% as the Bank of Canada tightens further, this downward price discovery will probably persist well into next year.

In Ontario, for example, the sales-to-new listings ratio has weakened to just above the 40% level. In some markets outside the core of the GTA, benchmark prices are easily down 15%-to-20% from their early-year highs already. It’s a similar situation in B.C. where, while Vancouver is correcting, markets 1-to-2 hours outside the core are doing so even faster—none of this is a surprise given how sharply these exurban markets ballooned during the pandemic. Meantime, Atlantic Canada is holding up relatively well thanks to an ongoing population influx, while Alberta (and the Prairies more broadly) still look pretty solid.

The table below shows the decline in average 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 largest price dips are in the GTA and the GVA, where the price gains were spectacular during the COVID-shutdown.

Bottom Line

The Bank of Canada slowed its tightening pace to 50 bps when it met in late October. Since then, the US inflation has slowed a bit, causing longer-term bond yields to fall meaningfully. Tomorrow, Canada will release its latest inflation report. All eyes will focus on core inflation (which excludes food and energy prices) in the hopes that evidence will also validate a slowdown in those measures.

The Bank of Canada’s policy announcement date is not until December 7th, when another rate hike is widely expected. Tomorrow’s inflation report will give us a better sense of whether a 25-bps hike might be possible.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

The Bank of Canada Slowed the Pace of Monetary Tightening

The Governing Council of the Bank of Canada raised its target for the overnight policy rate by 50 basis points today to 3.75% and signalled that the policy rate would rise further. The Bank is also continuing its policy of quantitative tightening (QT), reducing its holdings of Government of Canada bonds, which puts additional upward pressure on longer-term interest rates.

Most market analysts had expected a 75 bps hike in response to the disappointing inflation data for September. Headline inflation has slowed from 8.1% to 6.9% over the past three months, primarily due to the fall in gasoline prices. However, the Bank said that “price pressures remain broadly based, with two-thirds of CPI components increasing more than 5% over the past year. The Bank’s preferred measures of core inflation are not yet showing meaningful evidence that underlying price pressures are easing. Near-term inflation expectations remain high, increasing the risk that elevated inflation becomes entrenched.”

In his press conference, Governor Tiff Macklem said that the Bank chose to reduce today’s rate hike from 75 bps last month (and 100 bps in July) to today’s 50 bps because “there is evidence that the economy is slowing.” When asked if this is a pivot from very big rate increases, Macklem said that further rate increases are coming, but how large they will be is data-dependent. Global factors will also influence future Bank of Canada actions.

“The Bank expects CPI inflation to ease as higher interest rates help rebalance demand and supply, price pressures from global supply disruptions fade, and the past effects of higher commodity prices dissipate. CPI inflation is projected to move down to about 3% by the end of 2023 and then return to the 2% target by the end of 2024.”

The press release concluded with the following statement: “Given elevated inflation and inflation expectations, as well as ongoing demand pressures in the economy, the Governing Council expects that the policy interest rate will need to rise further. Future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding. Quantitative tightening is complementing increases in the policy rate. We are resolute in our commitment to restore price stability for Canadians and will continue to take action as required to achieve the 2% inflation target.”

Reading the tea leaves here, the fact that the Bank of Canada referred to ‘increases’ in interest rates in the plural suggests it will not be just one more hike and done.

Monetary Policy Report (MPR)

The Bank of Canada released its latest global and Canadian economies forecast in their October MPR. They have reduced their outlook across the board. Concerning the Canadian outlook, GDP growth in 2022 has been revised down by about ¼ of a percentage point to around 3¼%. It has been reduced by close to 1 percentage point in 2023 and almost ½ of a percentage point in 2024, to about 1% and 2%, respectively. These revisions leave the level of real GDP about 1½% lower by the end of 2024.

Consumer price index (CPI) inflation in 2022 and 2023 is anticipated to be lower than previously projected. The outlook for CPI inflation has been revised down by ¼ of a percentage point to just under 7% in 2022 and by ½ of a percentage point to about 4% in 2023. The outlook for inflation in 2024 is largely unchanged. The downward revisions are mainly due to lower gasoline prices and weaker demand. Easing global cost pressures, including lower-than-expected shipping costs, also contribute to reducing inflation in 2023. The weaker Canadian dollar partially offsets these cost pressures.

The Bank is expecting lower household spending growth. Consumer spending is expected to contract modestly in Q4 of this year and through the first half of next year. Higher interest rates weigh on household spending, with housing and big-ticket items most affected (Chart below). Decreasing house prices, financial wealth and consumer confidence also restrain household spending. Borrowing costs have risen sharply. The costs for those taking on a new mortgage are up markedly. Households renewing an existing mortgage are facing a larger increase than has been experienced during any tightening cycle over the past 30 years. For example, a homeowner who signed a five-year fixed-rate mortgage in October 2017 would now be faced with a mortgage rate of 1½ to 2 percentage points higher at renewal.

Housing activity is the most interest-sensitive component of household spending. It provides the economy’s most important transmission mechanism of monetary tightening (or easing). The rise in mortgage rates contributed to a sharp pullback in resales beginning in March. Resales have declined and are now below pre-pandemic levels (Chart below). Renovation activity has also weakened. The contraction in residential investment that began in the year’s second quarter is projected to continue through the first half of 2023, although to a lesser degree. House prices rose by just over 50% between February 2020 and February 2022 and have declined by just under 10%. They are projected by the Bank of Canada to continue to decline, particularly in those markets that saw larger increases during the pandemic.

Higher borrowing costs are affecting spending on big-ticket items. Spending on automobiles, furniture and appliances is the most sensitive to interest rates and is already showing signs of slowing. As higher interest rates work their way through the economy, disposable income growth and the demand for services will also slow. Past experience suggests that the demand for travel, hotels, restaurant meals and communications services will be impacted the most. Household spending strengthens beginning in the second half of 2023 and extends through 2024. Population growth and rising disposable incomes support demand as the impact of the tightening in financial conditions wanes. For example, new residential construction is boosted by strong immigration in markets that are already particularly tight.

Governor Macklem and his officials raised the prospect of a technical recession. “A couple of quarters with growth slightly below zero is just as likely as a couple of quarters with small positive growth” in the first half of next year, the bank said in the MPR.

Bottom Line

The Bank of Canada’s surprising decision today to hike interest rates by 50 bps, 25 bps less than expected, reflected the Bank’s significant downgrade to the economic outlook. Weaker growth is expected to dampen inflation pressures sufficiently to warrant today’s smaller move.

A 50 bps rate hike is still an aggressive move, and the implications are considerable for the housing market. The prime rate will now quickly rise to 5.95%, increasing the variable mortgage interest rate another 50 bps, which will likely take the qualifying rate to roughly 7.5%.

Fixed mortgage rates, tied to the 5-year government of Canada bond yield, will be less affected. The 5-year bond yield declined sharply today–down nearly 25 bps to 3.42%–with the smaller-than-expected rate hike.

Barring substantial further weakening in the economy or a big move in inflation, I expect the Bank of Canada to raise rates again in December by 25 bps and then again once or twice in 2023. The terminal overnight target rate will likely be 4.5%, and the Bank will hold firm for the rest of the year. Of course, this is data-dependent, and the level of uncertainty is elevated.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Bank of Canada Will Not Be Happy With This Inflation Report

Canada’s headline inflation rate ticked down slightly last month to 6.9%, but measures of core inflation remain stubbornly high, and food prices hit a 41-year high. Lower gasoline prices were primarily responsible for the decline in inflation in the past three months. Bond markets sold off on the immediate release of the data this morning, taking the 2-year yield on Government of Canada bonds to over 4%. This is the last major data release before the Bank of Canada’s policy rate announcement next Wednesday, October 26, which puts the potential for a 75-bps hike back in play. At the very least, the Bank will take the overnight rate up 50 bps to 3.75%, but I wouldn’t rule out another 75-bps move. Judging from experience, we may see a nod in that direction by Governor Macklem before the Governing Council meets.

Excluding food and energy, prices rose 5.4% year-over-year (y/y) in September, following a gain of 5.3% in August. Prices for durable goods, such as furniture and passenger vehicles, grew faster in September compared with August. In September, the Mortgage Interest Cost Index continued to put upward pressure on the all-items CPI Canadians renewed or initiated mortgages at higher interest rates.

Monthly, the CPI rose 0.1% in September. On a seasonally adjusted monthly basis, the CPI was up 0.4%.
Average hourly wages rose 5.2% on a year-over-year basis in September, meaning that, on average, prices rose faster than wages. The gap in September was larger compared with August.

In September, prices for food purchased from stores (+11.4%) grew faster year-over-year since August 1981 (+11.9%). Prices for food purchased from stores have increased faster than the all-items CPI for ten consecutive months since December 2021.

Contributing to price increases for food and beverages were unfavourable weather, higher prices for essential inputs such as fertilizer and natural gas, and geopolitical instability stemming from Russia’s invasion of Ukraine.

Food price growth remained broad-based in September. On a year-over-year basis, Canadians paid more for meat (+7.6%), dairy products (+9.7%), bakery products (+14.8%), and fresh vegetables (+11.8%), among other food items.

Bottom Line

Price pressures might have peaked, but today’s data release will not be welcome news for the Bank of Canada. There is no evidence that core inflation is moderating despite the housing and consumer spending slowdown. The average of the Bank’s favourite measure of core inflation remains stuck at 5.3%. Combined with the Governor’s recent harsh rhetoric, the high probability that the Fed will hike rates 75 bps at the next Federal Open Market Committee Meeting and the weak Canadian dollar, there is no doubt the Bank will increase their overnight policy target to at least 3.75%, and could well go the full 75 bps to 4.0% next week. I would bet that they will not quit there, with further hikes to come in December and next year by central banks worldwide.

The Government of Canada yield curve is now steeply inverted, reflecting the widely held expectation that the economy is slowing. The prime rate will increase sharply next week, increasing variable mortgage rates again. Fixed mortgage rates will rise as well, but not by as much, continuing a pattern we’ve seen since March when the Bank of Canada began the current tightening cycle. We are unlikely to see a pivot to lower rates in the next year as inflation pressures remain very sticky.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres