Canada’s inflation cooled to 3.1% in October. Robert Both, Macro Strategist with TD Securities, discusses the latest readings and the implications for the Bank of Canada’s monetary policy with MoneyTalk’s Greg Bonnell.
Greg Bonnell: Well, Canadian headline inflation cooled to 3.1% in October, just sitting above that target range for the Bank of Canada. So is it safe now to say that our Central Bank’s hiking cycle is finished? Joining us now to discuss, Robert Both, Macro Strategist with TD Securities.
Robert, great to have you on the program. Let’s start with what we got out of the inflation print today. 3.1% is the headline, what did you find interesting?
Robert Both: So as you mentioned, we are just sitting right above the target range now. So that 0.7 percentage point drop, that is a lot of good news for Canadians that are struggling with a higher cost of living. It’s also great news for the Bank of Canada, because inflation is that much closer to their end goal.
Now as with every CPI report, there are a lot of moving pieces under the headline number. And in this one, we saw a very stark divergence between energy prices and shelter prices. So energy prices were the main downward force in October. Gasoline prices fell by about 6.4% on the month. You also had a drag from electricity and heating fuels.
So when you strip some of that out, the headline numbers look a little bit less positive. We also saw more pressure come through the shelter channel in October. So that is going to be something that’s a little tougher to digest for those households that are a little more financially stretched.
Rents have been a key driver of CPI for the last several months. But those accelerated further in October. Rents saw their largest month-over-month increase in a few decades. So that is certainly something that speaks to the shortages across the housing market.
We also saw more pressure come through mortgage interest costs, through property taxes as well, so a much larger increase than they had last year. So you’re really seeing a bit of a gap open up between shelter prices and the broader CPI basket. I think the biggest thing that stood out to me today, though, was the improvement we saw for the Bank of Canada’s core inflation measures. Those had been running at about 3.8% year over year in October — or in September. In October, they’re sitting around 3.55%.
And the Bank of Canada has been keenly focused on the three-month rates of core inflation. And those have been maintaining a very tight range over the last 12 months. But we actually saw them break below that range in October. Those three-month rates of core inflation were running at 3.7% in September. They’re now at 3.0%, which is just the upper end of the Bank of Canada’s target range. So we are going to need to see a couple more months of this to really make this a trend. But it should give the bank a little more confidence that its tight policy stance is helping to relieve price pressures, and that inflation does still remain on a path to 2%.
Greg Bonnell: Because I think, we’re not that far away, right? December 6, I had forgotten that December is right around the corner. We’re going to get another rate decision from the Bank of Canada. It seems like a funny time.
Because when you think about it, like are they on hold, or this is like– well, our central bank, the States, they haven’t done anything since the summer. But after what we’ve been through, we’re all pretty much on edge as to what do they do next. What do you think we get? What’s the message from December the 6th? First, what are they going to do about rates?
Robert Both: So we don’t expect the Bank of Canada to cut rates until the middle part of next year. And I think for December, there is a pretty high bar for any sort of change in tone or signal that rate cuts might be a little bit closer. The bank has actually been more focused on the risk of hikes over the last few months, really since July. They haven’t done much. But they have kept that threat of hikes on the table, and that’s helped to keep financial conditions tight.
We expect that message to remain unchanged in December. The bank does need to see more progress on the inflation front to take the risk of hikes off the table. But we think with a couple more months of softer core inflation, and if we continue to see progress on the headline front as well, we are getting a little bit closer to when you can expect that change in tone from the bank.
Greg Bonnell: Is part of the sort of issue now for the Bank of Canada, not so much the data that they see coming in, because it all seems to be moving in the direction they would hope it would move in after being so aggressive with rate hikes, but how we start reacting to things? I just think back to the spring when they said, oh, we’re going to stop here and see what kind of effect we’ve had on the economy.
And the housing market took off again. And then they came back to the table in the summer and hiked some more. That really cooled things down. Are they worried about how we’re going to react in the short term to small shifts?
Robert Both: Right. So I think the bank is very aware of how its communication is interpreted by markets, by the broader financial community. And that is part of the desire to keep financial conditions tight, to keep the risk of hikes on the table until they are much closer to easing, until they have more evidence that this isn’t just a one-off like we saw last spring. This is a firmer trend towards 2% inflation in a balanced economy.
I think the biggest difference is between what we saw in January and where we are today is just the broader state of the economy. Back in the early parts of this year, labor markets were still very tight. We were still in a state of excess demand.
We’ve seen two very weak quarters of GDP growth now. The Canadian economy contracted in the second quarter. It looks like its growth has remained pretty flat over Q3 as well. And you’re starting to see that excess supply creep back into the economy.
So I think the bank still doesn’t want to tip its hand until it is certain that cuts are on the horizon. But with a couple more data prints, and if we do see more progress on those core inflation measures, we could be getting closer to that point in the new year.
Greg Bonnell: How does the new year look in terms of the economy, in terms of jobs? I mean, I think this has been a very aggressive hiking cycle. I think, perhaps, some of the effects of the rate hikes took a little longer to work through the economy. Is next year when we sort of see the full impact of what they’ve done?
Robert Both: So it is going to remain a very challenging environment for growth over 2024. I think the bigger source of uncertainty is what’s happening to the economy in Q3 and Q4 of this year, coming off that contraction in the second quarter. We do expect things to stabilize over Q4. We do expect to see it return to low, but positive growth. And over the course of 2024, we should get closer to those trend-like GDP numbers.
That does mean excess supply is going to continue building over the course of next year. And we don’t — well, we’ll also see a bit of a tailwind when the Bank of Canada does begin to ease off of its restrictive policy stance over the second half of the year. Now, population growth is still continuing to provide a key driver of GDP growth. So that is going to keep us from tipping into a steeper slowdown.
So we look for GDP growth of 0.9% next year. We think with that population growth, you are still going to continue to see a job growth throughout the year. But job growth will continue to be outpaced by the growth of the labor force. So we can see unemployment rate move higher as the economy moves further into excess supply. But we don’t expect the type of material job losses that you might anticipate with a weaker growth outlook.
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