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The Bank of Canada held its benchmark interest rate steady at 5% for the sixth consecutive time, as expected. Even though inflation and other indicators are heading in the right direction, Governor Tiff Macklem said the central bank needed to see this pattern for longer to be assured it is “not just a temporary dip.”
Scotiabank’s Chief Economist Jean-François Perrault is back to discuss the Bank of Canada’s latest decision, whether a cut in June or September is on the table and offer his thoughts on next week’s federal budget and what impact that could have on inflation.
For an up-to-date breakdown of the Bank of Canada's key interest rate and its change over time alongside inflation numbers, visit our interest rate page.
Key moments this episode:
1:06 — What can we take away from the Bank of Canada’s latest decision?
2:26 — The big question: When will rates finally come down?
4:00 — So, could we see a rate cut this summer?
4:50 — What would we need to see in terms of indicators for a June or July rate cut decision?
6:33 — What is happening in Canada’s housing market and what does it mean for inflation?
8:20 — Where do we stand on geopolitical risks when it comes to inflation?
9:15 — What about a weak loonie compared to the U.S. dollar? Is that a factor that could impact inflation?
10:45 — How do higher-than-expected U.S. inflation numbers complicate things when it comes to rate cuts?
12:23 — What risk does Canada’s low productivity pose?
13:31 — The Bank of Canada made a slight increase to its nominal neutral interest rate. What is that and why is that important?
16:27 — Is there anything else we can learn from the latest Bank of Canada Monetary Policy Report?
17:28 — What can we expect from the Federal Budget next week and how might that impact inflation and the Bank of Canada’s future decisions?
19:52 — The top three takeaways for Canadians from the latest Bank of Canada decision
Stephen Meurice: The Bank of Canada held rates steady again this week as expected.
Tiff Macklem at press conference: Now I realize what most Canadians want to know is when are we going to lower our policy rate?
SM: That’s Bank of Canada Governor, Tiff Macklem at a press conference on Wednesday.
Tiff Macklem at press conference: The short answer is we are seeing what we need to see, but we need to see it for longer to be confident that progress toward price stability will be sustained.
SM: Could it be at the next meeting in June? Or do we have to wait until September? Or maybe further? Here to help answer that question and dig into the latest Bank of Canada announcement, as always, is Scotiabank’s Chief Economist, Jean-François Perrault. He’ll talk to Armina Ligaya and give us the lay of the land when it comes to the Canadian economy and his thoughts ahead of next week’s federal budget, and what impact that might have.
I’m Stephen Meurice and this is Perspectives. Now here’s Armina Ligaya.
Armina Ligaya: JF, welcome back, as always.
Jean-François Perrault: Well, thank you.
AL: So, yet another rate hold, this time the sixth time in a row, as everyone widely expected. So, again, what can we take away from the decision today? Is there anything new in the latest statement?
JFP: I wouldn't say brand spanking new, but we got some more insights into how the governor [Bank of Canada Governer Tiff Macklem] is thinking about the rate decision. And there was some pretty interesting stuff there. The first is clearly the economy is better than they had anticipated. So, we've been thinking for a while that the economy was more resilient and seeing more growth than we thought was going to be the case. The governor confirmed that today, where they doubled their growth forecast for 2024. So that's a pretty meaningful change in how they see the economic growth environment. On the other hand, though, he did talk a lot about the fact that inflation had been slowing and this was a good sign, of course, and that other indicators of inflation such as wages and slack and supply chains and a range of other things suggested to them that the path that inflation was on was possibly conducive to a June rate cut, which was, I think, somewhat newsworthy. I mean, there's a question as to whether or not he actually meant to say what he did, but it kind of came out like his view was that they were on track for a June rate cut if things continue to proceed as they had been on the inflation side. From our perspective, that was that was a bit of a surprising thing. I don't actually think it's going to happen, but it was, I think, newsworthy.
AL: If I recall, the phrasing was a June rate cut is, ‘In the realm of possibilities.’
JFP: Exactly.
AL: So, that is the big question. When will rates finally come down? Because although there was some hinting at a June rate cut and many other economists are pointing to June, you somewhat recently pushed back that rate cut prediction to September. What is your view now? Is that still the same?
JFP: I mean, we still feel pretty comfortable with that. And clearly it's a little bit of a shakier call now that the governor has indicated that maybe he's got a preference to go sooner rather than later on that. But we like to look at the big picture. We have, as I said, growth is much stronger than we’d anticipated. We see that, retail spending – so consumer spending is higher, in fact, double what we thought was going to be the case. And again, the governor indicated that he was doubling his forecast for consumption this year. We've seen auto sales pick up a lot, we've seen the housing market pick up substantially so far this year. We've seen U.S. economic activity strengthen dramatically. We've actually seen on Wednesday, we got the U.S. inflation data, which is pretty strong, which is leading some folks to start to think, well, maybe the Fed might not even cut this year in addition to kind of relatively late breaking stuff, which is the provincial governments kind of roll out all their budgets for the next year and almost all of them increase spending very significantly. So that, again, provides impulse, if you will, to the economic side. So, had the governor not said that June is in the realm of possibilities, we would have felt even more comfortable about our September call based on how they view things now. But, we're just a little bit more shaky about that given that maybe the governor is reading things a little bit more optimistically than we would at this point.
AL: So, do you think we could see a rate cut this summer?
JFP: It strikes me as very unlikely. But the governor has got a different set of maybe considerations than we do. It is not inconceivable, for instance, that he decides to cut interest rates in June because he kind of is seeing the stars align and then instead of following that up with a series of rate cuts, just maybe he does one and waits to see how the economy evolves before deciding to do another one. So it could be that he does go in June, but actually does less this year than maybe we would assume if he were to go in September. And I think part of the challenge that he's got is if he goes too soon and maybe the housing market picks back up, maybe he's got less of an ability to cut later on in the year, which has always been our thinking. But we're kind of getting his insights in terms of how he thought on Wednesday and the press conference.
AL: I do want to go back a bit later to the various risks, including the housing market. But what are the key indicators that you're looking for in the coming months? Really, what would you need to see for a June or even a July rate cut?
JFP: Well, I think you need a range of things. So we need, obviously, the sooner the rate cut, the more progress we need to see on inflation. So we have a couple of more months of inflation data before June. We would need to see a continuation of the pretty positive trends on inflation that we've seen over the last couple of months. That is by no means a slam dunk, but we would at least need to see that. We would need to see evidence that wage growth is slowing substantially. And there isn't a whole lot of evidence of that being the case. In fact, we had last week the March labour force survey, which showed very limited — actually a bit of a decline in employment. So not great news on that front, but an acceleration in wage growth. And that's kind of inflationary at the margin. We would need to see, I think, pretty compelling evidence that the economy is slowing. Now, rewind – what we're seeing in the first quarter of this year so far is a very strong acceleration of economic activity in Canada, much to our surprise and everybody else's surprise. You would need to see a reversal of that in the relatively near future in order to, again, give us the confidence that maybe a June rate cut is the right thing to do or a July rate cut. But you need to see some combination of those things. Outside of our border, you would need to see evidence that the US economy is slowing and that maybe US inflation is not surprising to the upside anymore because it's been three or four months of chronic upside surprises to US inflation. Now we import a lot of stuff from the US so that that is a meaningful risk from a Canadian perspective. So just a range of things which need to all kind of point in the direction that a June cut or July cut, if that's what they want to do, is really the right thing to do, given the other risks to inflation, which we think are continuing to be tilted to the upside.
AL: So that’s a good check in on all the various elements of the economy that led to Wednesday's decision. I wonder if we could also check in on the various risks. One of them you mentioned was housing. That's a big one. Even in his opening statement, Tiff Macklem talked about how inflation's going down for things like food and travel, which is great, but shelter cost inflation remains very high and is the biggest contributor. So what are we seeing in the housing market right now? This is a typically busy time. It's spring. Even in my neighborhood, I see plenty of listings and open houses. So, what are we seeing? What does that mean for inflation and the Bank of Canada?
JFP: Yeah, the challenge from the Bank of Canada’s perspective is they don't want the housing market to pick up too soon. Because if the housing market picks up too soon, economic activity kind of accelerates as a result of that and of course house prices and maybe rents increase and that feeds inflation to some extent. So they're really conscious about that and they're right to be worried about that. What we've seen so far this year, the first couple of months is pretty strong, rebound in most housing markets. We've seen a little bit of a softness in March so far in some of the data. Nothing to be particularly worried about. But there's also one day less in March this year relative to previous years because of Easter. But it's pretty clear that the housing market is still a bit on knife edge in terms of this kind of supply-demand imbalance, which is heavily imbalanced towards demand relative to supply. And as a result of that, or at least we think, there's a very significant sensitivity to potential rate cuts in terms of tripping that market back into a pretty active phase and where demand is going to outstrip supply and of course, create those conditions that the governor said would be worrisome, which is higher activity and higher prices. So that that I think is a pretty is a pretty meaningful risk, particularly in the spring market, early summer market, given that that is typically the time when most transactions take place.
AL: The other risk that is still on the horizon, geopolitical risk, the conflict in the Middle East continues as well. Risks to commodity prices in the form of shipping disruptions. Where are we at with that? I think that we’re always talking about that as a potential risk. What has developed over the past couple of months? Has that changed?
JFP: I mean, it's a little bit less worrisome now than it was then. There has been an adaptation. Shipping routes have changed a little bit, but it’s still a risk. And it's a risk that remains, I wouldn't say critical from an inflation perspective, but at the point in time where, inflation still remains too high, as the governor indicated, there isn't really all that much room for maneuver to accommodate positive shocks to inflation, which could be the case if, for some reason, that transportation was further disrupted by developments in the Middle East or the Panama Canal. But over the last couple of weeks, last several weeks, it's been a little bit less worrisome in terms of impacts than we feared it might be. So that's, at the margin, good news.
AL: And what about weakness in the loonie? Obviously, that's not necessarily good for someone who, like me, recently traveled to the U.S., but in the reverse, that's really good for driving business towards our economy. Is that a factor that could potentially impact economic activity and inflation?
JFP: It could be. It could be. I mean, as I indicated, on Wednesday we received U.S. inflation, which was a bit stronger than expected. The latest in a series of U.S. inflation reports, which are a bit stronger than expected. And it could very well be that the Federal Reserve this year ends up cutting less than the Bank of Canada, which would be a reversal of how people have thought about this for many, many months now. And as a result of that, is this kind of reassessment of U.S. monetary policy relative to Canadian monetary policy, you are seeing a significant weakening of the Canadian dollar, so a depreciation of the Canadian dollar. And that means that anything that we import is more expensive. And that is, again, at the margin, inflationary. So it's a function of how much that currency moves will determine how inflationary that is. But certainly, over the last month or so, the movement in the Canadian dollar as markets have kind of tried to digest, ‘Who's going to cut more this year: The U.S. or the Bank of Canada?’ has, at the margin, made inflationary pressures a little bit trickier in Canada over the next several quarters. Though the thing with exchange-rate pass-through, as we call this, is it takes a while for that to have a full effect. So the fact that the exchange rate has moved over the last several weeks doesn't mean that inflation in April or May is going to rise as a result of that. But it could mean kind of later in the year 2025, you get a bit of an impact.
AL: And somewhat related to what you just mentioned, after the Bank of Canada had already made its decision, there was fresh numbers on inflation for the U.S. and that was higher than expected. So that too, is also going to factor in. How much does that make it more complicated? Because I believe the Fed said they had hoped to cut two or three times this year.
JFP: Yeah. So the Fed, in their most recent staff economic projections or the Humphrey-Hawkins testimony, indicated that the consensus view at the Fed was that they would cut three times this year. That quite honestly seems a little bit aggressive now, given what we've seen on the U.S. growth side, given what we've seen on the inflation side. And it's looking increasingly aggressive, given what we're seeing on the oil price side as well, because the other story behind all this is that over last several weeks, oil prices gone up a lot. West Texas Intermediate, kind of the benchmark crude, is about 85 bucks. That's up 15, 16 bucks since January. So it's a big move up that some of us are seeing at the gas pump already. Gas prices are probably going to rise further as a result of this. So we also know that in addition to the cost of imported goods in the U.S. probably rising because inflation in the U.S. is a little bit stronger, we're going to pay more for energy related products over the next several weeks, maybe a little bit longer than that. So that's, of course, an upside risk to inflation, which could be manageable. The Bank of Canada takes oil and energy prices out of inflation when it kind of assesses inflationary dynamics. But at a point where inflation is still, again, by the governor's own admission, uncomfortably high, the tolerance for the impact of high oil prices on inflation or on how Canadians think about inflation is probably going to be reasonably low.
AL: Another factor which you've already spoken with the podcast about is productivity. Now, just last month, the Bank of Canada said that productivity is an economic emergency and increasing productivity is a way to, quote: “inoculate the economy against inflation.” Obviously, this is a issue with a complicated solution, a longer-term solution. But I wonder if you could kind of weigh in a bit on that and what else, how that's a risk. What else could be done to sort of stem that risk?
JFP: Listen, I mean, it's a big risk because what it does is low productivity makes it harder for firms to manage wage increases. And we know wage increases have been substantial. So the fact that productivity has been declining is really a big headwind for the economy's ability to manage inflation pressures going forward. And I think that's partly why the senior deputy governor is talking about this. And unfortunately on that front, the news isn't great. Productivity has been pretty bad over the last couple of years, had a little bit of reprieve in the fourth quarter. We don't think that lasts. So productivity dynamics are challenging and they make the Bank of Canada’s job more difficult and they make it harder for us to manage the inflationary kind of impulses that the economy is faced with relative to situations where productivity growth is stronger, as we have seen in the US, say, for the last couple of years.
AL: So obviously the Bank of Canada did not move rates, but it did announce one move, which I'm hoping you can kind of explain to us. It made a slight increase to its nominal neutral interest rate: 25 basis points to a range between 2.25% and 3.25%. What is the neutral rate and what does this mean? Why is that important?
JFP: So it's important over a longer period time. It's less important from a short-term perspective, but the neutral rate is, it's basically a measure of what the kind of equilibrium interest rate for the economy is. And so if inflation is at 2%, if the economy is at full employment, everything is working fine, and the central bank doesn't need to be adding or taking away from economic activity, the interest rate at that time is what we consider to be a neutral interest rate. Now, we don't know exactly what it is, and that's why, for instance, the Bank of Canada’s got this pretty wide interval around what that might be – 2.25% to 3.25% – because it's inferred from a range of economic data and you get more clarity on that as time passes. So you have a better idea of what the neutral rate was five years ago than it is today. And that neutral rate concept matters because it helps the Bank of Canada evaluate whether or not its policies are restrictive or not. So you can think about in terms of like driving a car, right? When you're – well, for those of us who know how to drive stick or used to know how to drive stick – so at the neutral rate, you can think of your car being in neutral. And when the interest rate, the policy rate is above the neutral rate, you are stepping on the brakes. And when the Bank of Canada interest rate is below the neutral rate you're stepping on the gas. So that's kind of a quick and dirty way to figuring out how the neutral rate matters for folks. It's just simply: is the Bank of Canada stimulative or contractionary? And you evaluate that in relation to some measure of what the neutral rate might be.
AL: And so what's the significance of this being revised upwards?
JFP: Well, the significance is – so we know a few things. So interest rates have increased a lot in Canada and in the U.S. over the last couple of years. And we've seen, or at least we believe, that the impact of that rate increase is not as substantial as what we thought would have been the case, say, two years ago when the Bank of Canada started raising interest rates. So there's a question there: well, why is that? Why is the bank not as effective or why isn't this hurting as much as we thought it would have been had somebody said, ‘Listen, rates are going to be 5% in Canada in 2023, What do you think is going to happen?’ So an explanation is that the neutral rate has risen over time and that in fact, 5%, which is the Bank of Canada rate now, isn't as tight in monetary policy as we thought because the neutral rate has climbed. So the gap between the Bank of Canada rate and the neutral rate isn't as large as what it would be if the neutral rate had actually been towards the lower end of the range or below that range. So the fact that they're raising their estimate of the neutral rate basically is telling us they don't think the policy in Canada was as restrictive as they believed it to be when they set policy six months ago, a year ago.
AL: Ah, that’s interesting. And I also wondered, they released the latest monetary policy report on Wednesday. You mentioned some of the revised forecasts that came out of that. Is there anything else that we learned from that?
JFP: At the margin, I mean, we've known, for instance, for a long time, for a while now, that the governor has been concerned about the impact of fiscal policy on the economy and on his ability to manage interest rates in that environment. So we saw in Wednesday's report that they scaled up their anticipated impact of government spending on the economy just at the margin in 2024 and 2025, which is a bit of a surprise. We thought they would revise that more based on what we've seen the provinces do so far. And of course, we'll have the federal budget on the 16th, which will provide more clarity on that. That was not necessarily newsworthy but is interesting because it suggests to us that despite all of the things that the provinces are doing, that maybe the governor of the Bank of Canada isn't as worried about that as he used to be, because he hasn't revised his kind of forecasts for that as much as we thought they would have been doing, given what we've seen in the budgets.
AL: So you've mentioned that there's been a lot more spending seen in the provincial budgets. We're getting a little bit of information about what's in the federal budget. What can you tell us about what we can expect in the federal budget next week and how that would impact inflation, as well as the Bank of Canada's future decisions?
JFP: Yeah, I mean, it's pretty tricky. We know that Prime Minister Trudeau, Deputy Prime Minister Freeland have been out there making all kinds of announcements about support for the housing sector, for the military, for AI, and those are amount to billions of dollars, like $25-26 billion. So it's a lot of money. We don't know how much of that money is actually going to be spent, because some of this is investments in housing that require provincial cooperation and agreements. So there's uncertainty about that. There's uncertainty about the timing of these disbursements. So we kind of know the numbers. We don't know if that's going to be this year, next year or three years or five years. So at this point in time, we don't have enough information to form a judgment as to, is this going to be a meaningful shock to the economy, for instance, this year or next year? We’ll know a week from now, if that's the case or not. But at present, all we know is they're announcing a lot of spending that is going to have an impact on the economy at some point. We just can't scale when that might be or how much that might be in the short run.
AL: Well, what kind of spending would you be looking for that could potentially have that kind of impact?
JFP: So on the housing side, it's stuff about accelerating rental construction, making it easier for builders to build, making it easier for cities to approve housing. So it's all stuff that's, largely stuff that's designed to lower the cost of living over time. So you can't really fault them for trying to do that because the cost-of-living issues are real for Canadians. There's no question about it. The challenge is, as we have seen over the last couple of years, is when governments in the current environment try to do things to make things better for Canadians. They're doing so against kind of the attempts by the Bank of Canada to slow things down. So that's the risk is, surely well intentioned, I won't get into the provincial, federal, provincial issues with what they're proposing, but they're well intentioned in terms that they want to make things cheaper for Canadians by investing in the economy. But at this present time, investing in the economy as we're trying to slow things down, or as the Bank of Canada’s trying to slow things down just creates that additional conflict between the Bank of Canada and what they're trying to achieve versus what the government is trying to engineer for Canada. And that's the real challenge with what they've been doing and the provinces as well.
AL: So overall, from Wednesday's decision, what in your view is the top three takeaways for Canadians?
JFP: Well, I mean, the number one is clearly the Bank of Canada has got rate cuts in mind. There's no question about that. So it's nice to hear that that's the case. They’ve been flagging this for a while, but it's getting a little bit more concrete. The governor's been clear: listen, we're seeing more progress on inflation, revising growth up. But despite that, we're still we're still looking for rate cuts. So that's, I think, great news for folks. The other bit of good news, to the extent that it's news, not great news from our forecast perspective, if that's true. But good news for Canadians is that the governor seems to be thinking that if the stars align, that first rate cut may come in June. We don't think that's going to happen. But that is newsworthy in terms of what was announced on Wednesday. And the third is, we're still, I think, looking at a meaningful cut in interest rates over the next little while and whether that starts in June or whether that starts in September, it's virtually certain that by this time next year, rates in Canada are going to be significantly lower than they are now. So we're at the cusp of a reasonably significant set of rate cuts. It's just a question as to when that actually begins.
AL: JF, thanks as always for stopping by.
JFP: Well, thank you. It's always a pleasure to chat.
AL: I've been speaking with Jean-François Perrault, the Chief Economist at Scotiabank.