The Bank of Canada is getting compelling evidence – from its own data, no less – that its efforts to tame inflation are working. The question is whether they’re working fast enough.
Fast enough to satisfy the central bank that it doesn’t need to raise interest rates any further. Or, at least, fast enough to stave off another increase at next week’s rate decision.
On Friday, the bank released its quarterly surveys of businesses and consumers. The two surveys provide insights into the expectations of both the private sector and Canadian households on employment, wages and prices. In the current volatile cycle, they have become critical inputs for the bank’s outlook on inflation and interest rates.
These latest surveys – completed in late May – show an unmistakable softening in many of the elements that the bank is most concerned about at the current stage of its inflation fight.
Inflation expectations among both employers and workers are in decline. So are private-sector wage expectations. In fact, for the first time since early in the COVID-19 pandemic, the business survey indicated that most companies expect the pace of growth in labour costs to actually decrease in the next 12 months.
Consumers – especially those with mortgages – report that high interest rates will force them to reduce their discretionary spending. Companies anticipate that sales will slow over the next year; so will hiring. They report that labour shortages have eased.
The Business Outlook Survey Indicator – the overall gauge of business sentiment gleaned from the survey questions – fell to a seven-year low, excluding the COVID-19 crisis. Such levels of pessimism are typically more common in economic contractions, if not outright recessions.
In short, the surveys suggest that the Bank of Canada’s rate hikes are having their desired effect. It wanted to slow the economy, to cool demand, to ease labour-market tightness, to slow wage growth. It wanted to rein in rising inflation expectations. It’s all trending in the right direction.
But based on the way the central bank has framed the trends up until now, its interpretation of these numbers will temper “things are getting better” with “they’re still nowhere near good enough.”
Chiefly, the inflation expectations – considered critical to re-establishing inflation around the bank’s 2-per-cent target – are still well above their prepandemic norms. They’re even notably higher than prevailing inflation levels, especially among consumers – an indication that perceptions remain elevated.
It’s clear that we might be on the right track, but we still have work to do. Inflation, at 3.4 per cent in May, is still more than one percentage point above the bank’s comfort level. Expectations and perceptions haven’t caught up with inflation’s rapid decline (the rate is half of what it was just six months ago).
Still, to finish the job, is it at all clear that we need even higher rates? At 4.75 per cent, the Bank of Canada’s policy rate is already a couple of percentage points above what the bank generally considers the “neutral” level, at which the rate neither stimulates nor suppresses the economy. The bank could stop raising rates – or even lower them – and it would still be applying its brakes to inflationary pressures. And the key data are trending in the right direction, even if the destination is still well in the distance.
On Friday, Statistics Canada reported that gross domestic product was flat in April, after eking out a 0.1-per-cent gain in March – an indication that the economy has lost momentum after a surprisingly strong start to the year. On Thursday, another Statscan report showed that the country’s job vacancy rate had fallen to a two-year low in April, and wage growth stalled that month. Earlier in the week, the statistical agency reported a big step downward in inflation, including measures of core inflation.
Perhaps, after a bit of a diversion earlier in the year, we’re now seeing clearer signs of an economy that is feeling the pressure from the Bank of Canada’s rate hikes, both more deeply and more broadly. With the rate of inflation now nearly 1.5 percentage points below the bank’s policy rate, the implication is that in real terms, interest rates are becoming even more restrictive than they were a few months ago – which could accelerate their effect on the economy in the months to come.
Still, economists are split on how they think the Bank of Canada will interpret and react to the flow of data since its June 7 rate hike.
In one camp are those who believe that the flow of data provides ample justification for the bank to at the very least hold its policy rate steady at its July 12 decision, on the grounds that it’s increasingly confident that its rate policy is doing the desired trick. In the other camp are those who believe the bank will raise rates at least one more time, focusing its attention on how far away the key numbers still are from the end goal.
It’s quite possible that the decision-makers in the bank’s senior ranks are themselves of two thoughts. If they do, indeed, need a tie-breaker to tip the data scales one way or another, there is one more big indicator that could sway their thinking: Friday’s employment report for June. If the July 12 rate call is as close as it appears, the job numbers could seal the deal.