Stephen Meurice: To no one’s surprise, the Bank of Canada announced Wednesday that it’s holding its key interest rate at 5%, the third consecutive announcement where the bank has hasn’t raised the rate.
Does this mean the central bank is finished with rate increases that have seen it go to decades-high levels since it started raising rates in early 2022 in a bid to curb inflation? Can Canadians now look forward to rates starting to go down? And does it mean inflation is finally under control?
To answer those questions and more, Scotiabank Chief Economist Jean-François Perrault is back. He’ll tell Perspectives newsroom team member Armina Ligaya what the decision says about interest rates, inflation, and where the Canadian economy is headed.
I’m Stephen Meurice, and this is Perspectives.
Now, here’s Armina Ligaya.
Armina Ligaya: JF, thanks for joining us once again.
Jean-François Perrault: Thank you, it's a pleasure to be here.
AL: So with Wednesday’s decision, everyone across the board expected it to be a hold. So, no surprises there. But I'm wondering, is there anything new that we learned? What can we take away from the bank’s statement?
JFP: There wasn't anything new from our perspective. I mean, I think there are some people out there that were still hoping that the governor would indicate that he would start thinking about cutting rates soon, and he didn't say that. So that's maybe a disappointment to some folks. Again, it was totally expected or at least we expected that he would not say that, that he would continue to have this bias, concern about inflation still being above target and that, if anything, he would need to raise rates as opposed to cut them in the near future. And he kind of reiterated that. So, there wasn't really anything surprising other than maybe a bit of disappointment for folks who are kind of crossing their fingers and hoping there might have been a rate cut in there in the works.
AL: So from your point of view, was this the right move? Was this a no brainer in your view?
JFP: Oh, this was absolutely a no brainer. I mean, the reality is — and the governor indicated that — we know the Canadian economy is slowing. We know households are feeling the weight of past interest rate decisions. Same with businesses. And the governor acknowledged that. He said, ‘Listen, we know that what we've been doing is working. It's slowing and inflation is coming down a little bit.’ So optimistic on the inflation front, but inflation remains still quite above where they want it to be. And as a result of that, in our mind, it was pretty premature. It would have been pretty premature to indicate that is, you know, there's so much comfort with the way things are going that he, you know, is shifting to perhaps a bit of a cutting bias. So, we expected him to kind of keep some language in there to remind people to say listen, 'Don't count on us cutting rates. If anything, you know, we are more likely to raise than cut going forward.’ And just kind of putting people on guard for that. The challenge that he's facing in the current environment is, if he were to cut rates or if people were to believe that he would cut rates the next few meetings, that risks undoing some of the weakness that is already built into the system. Like he doesn't want to encourage people to go out there and spend like crazy right now because inflation is still too high. So, he's got this tightrope act of not scaring people, but making sure that people remain cautious in their spending decisions so that, he’s got better confidence that inflation hit 2% in a couple of years. You know, later next year when he does at least, we hope, start cutting interest rates.
AL: Do you do you still expect to see more lagging effects from the previous rate cuts? Like it takes a while for those to have an impact?
JFP: Oh, yeah and that's totally standard, right? It takes a long time for interest rates to feed through the economic system and, some of the rate cuts were done, rate increases done reasonably recently. Some were down a little bit longer ago. So, we expect that to affect how people spend next year and then probably into 2025 to some extent. So, it doesn't mean things are going to crash, but it does mean that, you know, some folks are going to have payments resetting on their mortgages next year and the year after that, and that will occur at a higher rate because of what the Bank of Canada's been doing.
AL: So the Bank of Canada has been in its wording sort of walking that tightrope. You know, this was the third consecutive hold, third time’s the charm, have we finally peaked in terms of rate hikes?
JFP: I think so. I think so. Again, like all signs are pointing to things moderating, to inflation going in the right direction. And that's very, very good news. It may not be good news for people that are impacted by slowing growth, but when you've been trying to control inflation, when you've been raising rates to make that happen and it's finally happening, it does give you a pretty good sense that they probably have peaked. Now, whether they’ve peaked or not, depends entirely on what happens to inflation. So inflation has to continue to slow. If it doesn't continue to slow, then no, they might not have peaked. But everything we're seeing right now suggests that we've got much greater confidence now that they've peaked than we certainly would have had a couple of meetings ago.
AL: Let’s do a gut check on inflation. After all of this, we're nowhere near the target, but where are we at and how much progress has been made thus far?
JFP: Listen, so we're coming closer to the targets. When you look at headline inflation, so stuff that includes oil prices and food and energy and all those kinds of things, it's at 3.1%. Now, that's a lot lower than it was a year ago. But the Bank of Canada target is 2%. It has a range around that of plus or minus 1%. So the range is from 1% to 3%. So you're kind of getting towards the top end of the range. But that that measure of inflation, reflects things that are largely beyond the Bank of Canada’s control, in particular oil prices. And we know those have come down a lot. So, when you look at the measures that the Bank Canada prefers, so these are measures that kind of filter out really volatile elements in inflation and that includes oil prices, it include mortgage interest costs. You know, inflation is kind of in a 3.5-4% range, so not quite at the top end of where the Bank of Canada’s range. And so that's the problem. That's what the Bank of Canada is trying to get down. So that stickiness at that level of 3.5-4% on these measures the Bank of Canada really cares about is what's preventing them from, you know, signaling that they're happy with the inflation outcomes, that they are comfortable that inflation is going to go down to 2%. You know, we're still some distance away from where that needs to be.
AL: What are the major risks on the horizon in terms of inflation? I think last time when you were on the podcast, we talked about the potential of the conflict in the Middle East impacting oil prices. Did any of that come into play or are there any other factors in terms of inflation?
JFP: No. So thankfully, that risk seems, from an economic perspective, seems well behind us. Oil prices have come down a little bit, in fact they’ve come down a lot depending on the timeframe that we're looking at. So, we can kind of set some of that aside. I mean, there's obviously as long as there's a conflict, there's never you can never set it completely aside. But we're much more optimistic about the macroeconomic consequences of that, which is that there really aren't any relative to say, a few months ago where this was kind of a new, live issue. You know, the risk on inflation is, I think, to a significant degree in Canada based on what's happening in labour markets. Labour markets remain reasonably strong. You know, wage growth is in the 5% range in Canada, which is extremely high given that inflation target is 2%. So there's an inconsistency there between, you know, if everybody's earning 5% more, it makes it very difficult for inflation to go down to 2%. And I think that's the fundamental challenge. That, combined with what we know to be extremely disappointing productivity growth in Canada. So wages are rising much more rapidly than productivity. That means that wage growth is actually quite inflationary. That to us is the big risk on the inflation side as we go forward. If we don't see a moderation in wage growth, it's going to be difficult for the Bank of Canada to say, ‘Listen, we're super happy with the inflation risks.’ Because labour costs are an extremely important determinant of business costs.
AL: What other factors are we looking for in the coming month or two that will further inform where rates will be headed in the next year?
JFP: Well, there's always a whole bunch of stuff. But the two big things for us are what's going on in the labour market. So wages and job growth and how much the unemployment rate picks up. And of course inflation data, you know, we're not going to say we're flying blind on inflation, but there still is a lot of uncertainty about the path inflation goes from here. And of course, the more that data accumulates and confirms that, in fact, inflation slowing or not, again, we think it's going to slow, but there could be some surprise there. Those two things, I think will be the most informative for where rates go over the next seven or eight months or a year.
AL: And what is your take on the state of the economy from the prospect of a recession or not at this point?
JFP: So a recession is a tricky concept. You know, folks talk about a technical recession, which would be two quarters of negative growth. Now, we had a quarter of negative growth in the third quarter, you know, so we're, you know, possibly on track for that depending what happens in the fourth quarter. But it needs to be kind of a broad decline in economic activity. So a lot of industries falling, unemployment picking up a lot. So a lot of people losing their jobs. And that we're not that we're not seeing yet. The last four months in Canada, we added some 140,000 jobs. So the labour market is still tight. It's not as tight as it was, but it's still reasonably tight. So we're in the camp of those who think there's going to be a slowdown. Obviously, we're seeing that, but that slowdown is going to be reasonably moderate, you know, more like a stall or just, you know, spinning in neutral for a little bit until rates start to get cut. And then we expect then a bit of a pickup in economic activity in the second part of the year. We're not in the camp of those who think there's going to be a very painful economic adjustment over the next couple of quarters. And, in fact, you're seeing, the story of the last year, year and a half has been how resilient Canada has been to higher interest rates. That's why, in fact, rates are at 5% because economy has not slowed as much as we would have thought given higher interest rates. And you're seeing some of that resilience still play out. We had, for instance, in September retail sales were quite a bit stronger than we anticipated. The tracking for StatsCan for retail sales in October is actually very strong. So it could be that this resilience that we've been living through is still kind of hanging in there and keeping things a little bit stronger than we would than we would expect.
AL: So should Canadians just expect higher than normal rates for longer?
JFP: Yeah. There's no question that we are not going back down to rates before the Bank of Canada started raising, we're not going back to emergency rate settings. We're not going back to rates that we saw pre-pandemic anyways, which were which were, you know, depressed for the opposite reason that we're dealing with now, which is inflation had been too low since the financial crisis. So we are expecting rates to go down reasonably aggressively, but not down to levels that people might have been accustomed to. So, you know, maybe the Bank of Canada stops cutting at 3% at some point or 2.5%, which are both, from our perspective, perfectly normal rates. But from the perspective of somebody who's, you know, been a borrower in last 15 years, pretty elevated rates.
AL: For sure, so I do want to go back into another favourite topic, which we always ask about, speaking of homeowners, it's the question that's foremost in their minds: rate cuts. When you were on the podcast in October, you thought there would be a cut mid-next year, late spring or early summer. But before this announcement, looking at investors, they were pricing in a rate cut by as early as March. So what are your thoughts on this now?
JFP: Yeah, I mean, we're still the same view. We still think the Bank of Canada are going to cut around midyear and they'll cut by about 100 basis points next year. So, you know, a reasonable amount of cutting. But you're right, markets have got something priced in a little bit earlier than that. In fact, markets had the possibility rate cut priced in for this meeting. So markets have been pretty aggressive in expectations on the cutting side. Not so much of the total magnitude of cuts, but the timing of those cuts. It seems to us a little bit ambitious for Bank of Canada to cut in the spring for the very simple reason that we know that one of the reasons that they had to hike rates again this year, after they paused in January was the response to the housing market. So soon as people saw or believe that rate cuts were done and that we would kind of possibly be cutting sometime in the year, we never believed that, but there were some folks who believed that — you saw a very significant increase in the housing market. Now when the Bank of Canada is trying to slow things down and keep things slow, you know, they're not going to want to signal to people in the spring market, Buy a place now because rates are going down.’ And that might kind of imperil the slowdown they've engineered and might require them to forestall increases or, cut less, if people start to behave in a in a pretty aggressive fashion with respect to the real estate market, if they anticipate those cuts. So that's why we think kind of middle of the year as opposed to as opposed to earlier in the year.
AL: That makes sense because the spring market’s the big market. Did something like that happen, was there some sort of anticipation and response in the market to lower rates?
JFP: Yeah, there was. So in January 2023, the Bank of Canada announced a pause. Basically, they'd increased interest rate very aggressively, they didn't quite know how that's going to work. So they said, we'll stop for a while and see how things work out. And very quickly folks saw the pause and started to think, ‘Okay, well, that's as high as mortgage rates are going to go, I can then go back into the market either because I know I'm not going to get burned by higher rates or rates are going to get cut.’ And that led to a very significant pickup in housing market activity in spring. And that was a mistake on the Bank of Canada's part, there's no question about it. I think they probably learned from that episode.
AL: So the Bank of Canada is the first of the major central banks to come out with the decision. So is the Bank of Canada the canary in the coal mine, if you will? What does this announcement tell us about what the other banks are going to do?
JFP: I think they're all more or less in the same spot. You know, the U.S. economy, inflation's been behaving a little bit better in the U.S. than it has in Canada, but their economy is actually very strong now. Third quarter is extremely strong. It looks like the fourth quarter is going to be much stronger than we'd anticipated. So the U.S. economy is actually more resilient than the Canadian economy in some ways. And, you know, Chairman Powell’s got a similar concern that, you know, inflation's come down, it's not quite where they want it to, but it's come down and an environment of strong growth. So he's not, I don't think, likely to communicate that he's getting ready to cut rates anytime soon because, again, central banks around the world who are in the inflation fighting mode still need to see some signs of economic slowdown before they feel comfortable, and of course inflation slow down before they feel comfortable enough to say, ‘Okay, let's change the tone a little bit on where we're going to do what we're going to do with rates.’ So I think it's still too early for most central banks to be public about that.
AL: So going back to the Bank of Canada announcement Wednesday, for the average Canadian, what would you say are the three key takeaways from the announcement as we head into the new year?
JFP: Well, the first is very clearly, rate increases are working, so things are slowing. And Canadians can expect to be in an environment where there more economic uncertainty going forward than we experienced because we are kind of slowing down. We expect slower consumption, slower hiring. It's going to be a more challenging economic environment. So that's obviously not great news, but it is proof that the Bank of Canada's efforts have been successful finally in some sense. So that's one thing. The second is, inflation is not going it's like it's not disappearing. Inflation is lower. But nobody should expect that, you know, six months from now, we're going to be at 2% and everything will be great. And nor should people expect that as inflation moderates, that that means the price levels go back to where they were. Because there is this misconception out there about inflation that, you know, if you get inflation under control, then the cost of living all of a sudden becomes more reasonable. That's not how inflation works. Inflation is simply the rate of growth in prices. So things were unaffordable this year and inflation is 2% next year, they're still unaffordable next year. So that that's important to keep in mind. And then the third and maybe the most important I think, for Canadians is we do seem to be at a point where rates have probably hit their peak. And I think it's reasonable for people expect that rates will be cut next year. There's a matter of timing as to when that happens. But that's that seems I mean, it seems like a pretty good path for that right now. There's risks around that and maybe that, again, there might be another two rate increases between now and then if inflation doesn't behave. But the more information we get, the more comfortable we are with this view that rates are going to be cut reasonably aggressively in the second part of next year. And I think that's great news for Canadians.
AL: JF, thank you so much for weighing in on this and for joining us, as always.
JFP: Thank you. It's always a pleasure to talk to you.
AL: I've been speaking with Jean-François Perrault, the chief economist at Scotiabank.
