A Collective Sigh of Relief As The BoC Cut Rates For the First Time in 27 Months

With continued evidence that underlying inflation is easing, the Governing Council agreed that monetary policy no longer needs to be as restrictive. Recent data has increased our confidence that inflation will continue to move towards the 2% target. Nonetheless, risks to the inflation outlook remain. “Governing Council is closely watching the evolution of core inflation and remains particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

As shown in the second chart below, the nominal overnight rate remains 215 basis points above the current median CPI inflation rate, which shows how restrictive monetary policy remains. The average of this measure of real (inflation-adjusted) interest rates in the past 30 years is just 60 bps. The overnight rate is headed for 3.0% by the end of next year.

There are four more policy decision meetings before the end of this year. It wouldn’t surprise me to see at least three more quarter-point rate cuts this year. While the overnight rate is likely headed for 3.0%, it will remain well above the pre-COVID overnight rate of 1.75% as inflation trends towards 2%+ rather than the sub-2% average in the decade before COVID-19.

In the first quarter of 2024, higher household spending on services—primarily telecom services, rent, and air transport—was the top contributor to the increase in GDP, while slower inventory accumulation moderated overall growth. Household spending on goods increased modestly, with higher expenditures on new trucks, vans and sport utility vehicles.

On a per capita basis, household final consumption expenditures rose moderately in the first quarter, following three-quarters of declines. Per capita spending on services increased, while per capita spending on goods fell for the 10th consecutive quarter.

Business capital investment rose in the first quarter, driven by increased spending on engineering structures, primarily within the oil and gas sector. Business investment in machinery and equipment also increased, coinciding with increased imports of industrial machinery, equipment and parts.

Resale activity picked up in Q1, driving the rise in housing investment, while new construction was flat. Ontario, British Columbia and Quebec posted the most significant volume increases in resales, while prices in these provinces fell in the first quarter.

New housing construction (+0.1%) was little changed in the first quarter, as work put in place decreased for all dwelling types except double houses. Costs related to new construction, such as taxes and closing fees upon change in ownership, increased in the quarter and were mainly attributable to newly absorbed apartment units in Ontario.

The household savings rate reached 7.0% in the first quarter, the highest rate since the first quarter of 2022, as gains in disposable income outweighed increases in nominal consumption expenditure. Income gains were derived mainly from wages and net investment income.

Investment income grew strongly in the first quarter of 2024 due to widespread gains from interest-bearing instruments and dividends. Higher-income households benefit more from interest rate increases through property income received.

Household property income payments, comprised of mortgage and non-mortgage interest expenses, posted the lowest increases since the first quarter of 2022, when the Bank of Canada’s policy rate increases began.

This is the last major economic release before the Bank of Canada meets again on June 5. Traders in overnight markets put the odds of a rate cut at next week’s meeting at about 75%, up from 66% the day before. Bonds rallied, and the yield on the Canadian government two-year note fell sharply, reflecting this change in sentiment.

The Bank of Canada has good reason to cut the overnight policy rate next week. Core inflation measures have decelerated sharply in recent months, and the economy is growing at a much slower pace than the central bank expected. The Bank has been very cautious, and there remains the possibility that they will wait another month before pulling the trigger on rate cuts, but at this point, we see no reason to delay any further.

Home sales activity recorded over Canadian MLS® Systems fell 1.7% between March and April 2024, a little below the average of the last ten years.

The number of newly listed properties rose 2.8% month-over-month.

Slower sales amid more new listings resulted in a 6.5% jump in the overall number of properties on the market, reaching its highest level just before the onset of the COVID-19 pandemic. It was also one of the largest month-over-month gains, second only to those seen during the sharp market slowdown of early 2022.

“April 2023 was characterized by a surge of buyers re-entering a market with new listings at 20-year lows, whereas this spring thus far has been the opposite, with a healthier number of properties to choose from but less enthusiasm on the demand side,” said Shaun Cathcart, CREA’s Senior Economist.

With sales down and new listings up in April, the national sales-to-new listings ratio eased to 53.4%. The long-term average for the national sales-to-new listings ratio is 55%. A sales-to-new listings ratio between 45% and 65% is generally consistent with balanced housing market conditions, with readings above and below this range indicating sellers’ and buyers’ markets, respectively.

There were 4.2 months of inventory on a national basis at the end of April 2024, up from 3.9 months at the end of March and the highest level since the onset of the pandemic. The long-term average is about five months of inventory.

“After a long hibernation, the spring market is now officially underway. The increase in listings is resulting in the most balanced market conditions we’ve seen at the national level since before the pandemic,” said James Mabey, newly appointed Chair of CREA’s 2024-2025 Board of Directors. “Mortgage rates are still high, and it remains difficult for many people to break into the market, but for those who can, it’s the first spring market in some time where they can shop around, take their time and exercise some bargaining power. Given how much demand is out there, it’s hard to say how long it will last.

The upcoming CPI data for April, released on May 21, will be crucial for the Bank of Canada. Given the strength in the April jobs report, the Bank is likely to hold off cutting interest rates until July.

Total hours worked in March were virtually unchanged but up 0.7% compared with 12 months earlier.

The details were similar to the headline: as full-time jobs dipped, total hours worked fell 0.3%, and only two provinces managed job growth. Among the type of worker, a 29k drop in self-employment was the primary source of weakness, while private sector jobs managed a decent 15k gain. The issue for the Bank of Canada is that wage gains are not softening even with a rising jobless rate. Average hourly wages actually nudged up to a 5.1% y/y pace, now more than two percentage points above headline inflation. With productivity barely moving, these 5% gains will feed into costs and threaten to keep inflation sticky.

The central bank meets again next Wednesday, and a rate cut is unlikely. I still expect rate cuts to begin at the following meeting in June. The Canadian economy, though resilient, will suffer from rising mortgage costs as many mortgages come under renewal over the next two years. Delinquency rates have already risen. Moreover, the planned reduction in temporary residents will also slow economic activity.

With the US jobs market still booming, it is likely the BoC will begin cutting rates before the Fed.

Excluding gasoline, the headline CPI slowed to a 2.9% year-over-year increase in February, down from 3.2% in January. Prices for rent and the mortgage interest cost index continued to apply upward pressure on the headline CPI.

On a monthly basis, the CPI rose 0.3% in February, the same as in January. The most significant contributors to the monthly increase were higher travel tours and gasoline prices.

On a seasonally adjusted monthly basis, the CPI rose 0.1% in February.

Prices for food purchased from stores continued to ease year over year in February (+2.4%) compared with January (+3.4%). Slower price growth was broad-based, with prices for fresh fruit (-2.6%), processed meat (-0.6%), and fish (-1.3%) declining. Other food preparations (+1.4%), preserved fruit and fruit preparations (+4.0%), cereal products (+1.7%), and dairy products (+0.6%) decelerated in February.

While grocery price growth has been slowing, prices continue to increase and remain elevated. From February 2021 to February 2024, prices for food purchased from stores increased by 21.6%.

The next meeting of the Bank of Canada Governing Council is on April 10. Before then, we will see two more important data releases:

1. The Bank of Canada Business Outlook Survey and Canadian Survey of Consumer Expectation and;
2. The Labour Force Survey for March.

Neither of these reports will likely derail the central bank’s move to cut interest rates by the June 10 meeting. Indeed, they could begin to cut rates at the April meeting. This would no doubt trigger a whopping Spring housing market, which is likely to be strong. There is significant pent-up demand for housing, and the prospect of home price increases could well move buyers off the sidelines if a surge in new listings comes to fruition.

The Canadian economy is particularly interest rate sensitive because of the vast volumes of mortgages that will be renewed in the next two years. Mortgage delinquency rates are already rising, so a gradual decline in interest rates is welcome news.

As the chart below shows, the three-month rolling average growth rates for the CPI trim and median core measures averaged 2.2% in February–their lowest reading in three years.

According to the Royal Bank economists, “Building on the January CPI report that was already showing broad-based easing in price pressures in Canada, the February report today reaffirmed those trends. Different measures of core inflation decelerated, and the diffusion index that measures the scope of inflation pressures also improved. That measure, however, was still showing slightly broader price pressures than pre-pandemic “norms”, suggesting there’s still room for more improvement.”

With the economy’s slow growth trajectory, the central bank has every reason to begin cutting interest rates soon.

The employment rate–the proportion of the population aged 15 and older who are employed–fell a tick to 61.5%. This is the fifth consecutive monthly decline, the most extended period of consecutive decreases since the six months ending in April 2009 during the global financial crisis. The Bank of Canada has emphasized the importance of the employment rate in recent commentary.

The employment rate in February 2024 was down 0.9 percentage points from the recent peak of 62.4% observed in February 2023. This downward trend is associated with the unprecedented ballooning of the working-age population.

The labour force jumped 76,000 last month and is up more than 550,000 in the past year, while the adult population has surged by more than 1 million people (+3.2%), compared with a job increase of 368,000. Even very strong job growth is not keeping up with the torrid influx of new workers, dampening wage inflation.

Most of the new jobs were in the service sector, led by employment in accommodation and food services following a decline in the prior month. Also rebounding was employment in professional, scientific, and technical services. On a year-over-year basis, employment in this industry was up 85,000 (+4.6%), the second-largest year-over-year increase among industries, after transportation and warehousing (+104,000; +10.6%).

We will see one more Labour Force Survey on April 5th before the Bank of Canada meets again on April 10th. The all-important CPI inflation data will be released on March 19th.

Today’s report, while strong, suggests that the surge in the working-age population and the decline in job vacancies could continue to temper wage inflation. The Bank of Canada will need more proof before it releases the brakes and lowers interest rates.