Bank of Canada Governor Tiff Macklem at a news conference after announcing an interest rate decision in Ottawa on April 12.BLAIR GABLE/Reuters
The Bank of Canada is widely expected to hold the line on interest rates this week after inflation fell unexpectedly in September while economic growth continues to flounder.
Until a week ago, the jury was out on whether Governor Tiff Macklem and his team would increase borrowing costs again on Oct. 25. Inflation had been ticking higher over the summer, and Canada’s top central bankers were sending hawkish signals that more tightening might be needed to get rising prices under control.
A string of data releases published last week appear to have settled the case in favour of keeping the policy rate at five per cent on Wednesday, according to analysts and bond traders.
Soft retail-sales data from August showed that Canadians are feeling the pinch of higher interest rates and cutting back on spending. Meanwhile, the central bank’s quarterly business survey found that companies are gloomy about future sales, and plan to curb hiring and investment. These are positives from the Bank of Canada’s perspective, as it tries to slow the economy to reduce upward pressure on prices.
Most importantly, the inflation rate fell to 3.8 per cent in September from four per cent in August, Statistics Canada said last week. That’s still nearly twice the central bank’s two-per-cent Consumer Price Index inflation target. But it came in below Bay Street forecasts and marked a reversal after two months of accelerating price growth.
“Inflation has surprised on the upside relative to the central bank’s last forecasts in July. But most of that was driven by rising energy inflation more recently as global oil prices edged higher,” Royal Bank of Canada economists Nathan Janzen and Claire Fan wrote in a note to clients.
“The latest CPI data for September also looked decidedly better, with slower growth in the BoC’s preferred ‘core’ measures breaking a string of upside surprises.”
Interest-rate swaps, which capture market expectations about monetary policy, are pricing in a roughly 15-per-cent chance that the Bank of Canada raises interest rates this week, according to Refinitiv data. That’s down from around 40 per cent before the CPI report. Of 32 economists polled by Reuters, 29 expect the central bank to stand pat this week.
A sharp rise in global bond yields in recent months has already pushed up borrowing costs for households, businesses and governments.
Mr. Macklem told reporters two weeks ago that higher bond yields don’t necessarily preclude further rate hikes by the Bank of Canada. But other central bankers, including top officials at the U.S. Federal Reserve, have argued in recent weeks that higher long-term rates may be a proxy for more central bank moves.
“Make no mistake, the recent rise in bond yields is indeed a substitute for a rate hike,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients. “So while data on businesses and households has been mixed, there’s little question that financial conditions have tightened enough to offset any unanticipated strength in the economy.”
The Bank of Canada has raised interest rates 10 times since March, 2022, in the most aggressive campaign of monetary-policy tightening in decades. After two rate hikes over the summer, it held its policy rate steady in September but left the door open to additional rate hikes if inflation remains high and the economy doesn’t slow as much as expected.
Economists have been surprised by how resilient the Canadian economy has been to the interest-rate shocks over the past year and a half. However, the evidence is increasingly clear that higher borrowing and debt-service costs are taking a toll.
Gross domestic product contracted slightly in the second quarter and appears to have flatlined through the summer. The housing market has entered another slump, and the unemployment rate has moved up since the spring – albeit from a low starting point – while job vacancies have fallen.
“In contrast to the clouds of uncertainty hanging over the inflation outlook, we see considerably less ambiguity around the near-term path for GDP growth,” a group of Toronto-Dominion Bank rate strategists, led by Robert Both and Andrew Kelvin, wrote in a note to clients.
“The growth outlook has weakened substantially since the [central] bank published its July Monetary Policy Report, and while our base case remains a soft(ish) landing, there is very little to cushion against further growth shocks,” they said.
The Bank of Canada will publish a new economic forecast alongside its rate decision on Wednesday. Mr. Macklem said two weeks ago that the bank was “not going to be forecasting a serious recession.”
The bank’s most recent forecast from July shows economic growth stalling through the remainder of 2023 and the first half of next year. It projects inflation won’t return to two per cent until the middle of 2025.
While the economy appears to be shifting into a lower gear, analysts expect Mr. Macklem to maintain a hawkish tone on Wednesday, keeping the possibility of further rate hikes on the table. That’s because several key indicators the central bank is watching to determine future inflation aren’t co-operating.
Average hourly wages are growing at around five per cent annually, a pace that Mr. Macklem says is “not consistent” with price stability. Meanwhile, Canadian businesses continue to increase prices more frequently and by larger amounts than is normal. And both consumers and companies expect inflation will remain well above the bank’s two-per-cent target for some time – a belief that can feed into inflation itself.
CALLOUT: Is inflation changing the way you shop or what you buy? Are you thinking differently about how much you’ll spend during the holidays this year? Globe reporter Susan Krashinsky Robertson wants to hear from consumers about how they’re spending. If interested, send an email to srobertson@globeandmail.com.