Bank of Canada lowers overnight interest rate to 4.25% 

Stephen Meurice: Another Bank of Canada announcement. Another cut.

Tiff Macklem at press conference: Today, we lowered the policy interest rates by 25 basis points to 4.25%. This is the third consecutive decrease since June.

SM: That’s Bank of Canada Governor Tiff Macklem at his latest press conference. And though the cut was largely expected, it still comes as welcome news to Canadians. But beyond a slightly smaller mortgage payment or other borrowing cost, what does the rate cut tell us about the bigger economic picture? Here as always to parse this latest announcement is Scotiabank’s Chief Economist, Jean-François Perrault. He’ll tell Armina Ligaya where we are in this cutting cycle, what effect it's had on the economy so far, and what might be on the horizon. I’m Stephen Meurice and welcome to a new season of Perspectives. Now here’s Armina Ligaya.

Armina Ligaya: JF, welcome back to the show.

Jean-François Perrault: Well, thank you. 

AL: So, what’s your reaction to this latest announcement? Anything stand out to you?

JFP: No, to be honest. This was expected, the communications around it were pretty clear. The governor continued to indicate that he was on a path to cutting interest rates. So this the third in a row. There are more to come. He indicated some concerns about inflation to the upside and to the downside, like he has in the last several meetings. Indicated some concern about the economic outlook like he has in the past several meetings. So there's really nothing surprising in today's announcement other than it's good news for people that rates are once again on the way down. 

AL: We’re obviously every time reading between the lines, parsing every word. Did we learn anything or glean anything about the cutting cycle?

JFP: Well, I suppose at the margin there is some stuff. I mean, there are some folks out there who think the Bank of Canada needs to cut more. So, you know, maybe a 50 basis point cut or more aggressively than they've been doing. And the governor didn't give an indication that he's thinking about that. So it doesn't look like we're on a path to more rapid and greater rate cuts than we thought that we had been on. There is some chat out there about the strength of the economy and whether there's a recession in the winds or if we’re soft landing or not. And the governor seemed reasonably comfortable with the outlook, didn't indicate any particular concern about the pace of economic activity. Maybe he's got to scale back their forecast just a tiny touch, but didn't suggest any greater concern about the state of the world than he had in last several meetings. So again, it's, a pretty straightforward meeting or decision, we think, at this point. 

AL: And so your thinking on the pattern of rate cuts from for the rest of the year, so that's two more decisions and into 2025, is the same? 

JFP: I mean there's a little bit of uncertainty about the path going forward. So we do think they cut again in October, which is the next meeting of the following meeting after that in December. Now, we have been expecting them to take a bit of a pause in December, it'll be four rate cuts in a row. You know, see how the economy handles that, see if there's a need to accelerate or maybe they've done too much or not enough at that point. So we had been thinking about a pause in December for one meeting.  You know, maybe that's a little bit more up in the air given that inflation is coming in reasonably close to targets and the risk around inflation seem to be moderating a little bit. So we're getting a little bit more comfort that maybe they can go ahead with a fifth cut in a row in December. But we're not quite there yet. 

AL: I wanted the temperature on the previous two cuts, the impact of those thus far. For example, obviously borrowers, home buyers, each cut is definitely a blessing. But what have we seen in terms of the housing market at this point?

JFP: Well, not a whole lot, to be honest. And it's a bit of a surprise, but it's a comforting surprise in the sense that, our fear was that the sooner they went this year, they went in June, we thought they would go a little bit later than June. That if they went too early, that it would stimulate the housing market recovery that would lead to higher prices and an excess of activity or some overly active markets which might then imperil future rate cuts. So it's actually been pretty comforting the fact that with the rate cuts that we've seen, which is only 75 basis points or 50 basis points before the most recent move, that that hasn't led to a big pick up in housing markets. So that's actually a good thing. Maybe not a good thing if you're trying to sell your house, but it's a good thing from a continued rate cut perspective. Where we are seeing things, for instance, is kind of more in their short-term rate decision space. So one of the things that we'd observe, say, in the beginning of the year was or for the early months of the year, car sales had slown down because buyers anticipated borrowing costs to come down. And as those costs have come down, say, prime lending rates have come down, so line of credit rates have come down. Borrowing costs of cars have come down, you’ve seen in last three months an acceleration in car sales, which is probably kind of an early reaction to those rate cuts. Now, that being said, there are other things that are going on other than simply the Bank of Canada. And obviously we think about Canadian interest rates from a Bank Canada perspective. But what's occurred over the summer, the last several weeks actually, is there has been a pretty significant repricing of rate cut expectations in the United States. As that's occurred, it's led to very significant falls in longer term interest rates in the U.S. and that's spilled into Canada. So we've seen, for instance, you know, 40, 50 basis point moves in some cases more than that, some case a little bit less than that, say, in the two or five or ten year space, which are also affecting borrowing costs with a bit of a lag. So there's kind of this double whammy of lower short-term interest in Canada because what the Bank of Canada has been doing, but lower longer-term interest rates because how people think about what the Fed is going to be doing. 

AL: Because the Fed is essentially teed up to cut later this month.And so then how would that factor into the Bank of Canada's current decision and further decisions going forward?

JFP: Well, the governor has been at pains to say that it doesn't really matter. That he sets monetary policy for Canada. We have a flexible exchange rate, which means that, he will set interest rates in a way that he believes is best for inflation if you're in Canada. If the Americans do something similar or not, it doesn't really matter. The exchangeable rate will adjust for that. That's what he said. Now, the reality is that's a little bit simplistic because we know and we've seen over the last several weeks again what happens in the U.S. rates space impacts credit markets in Canada and borrowing costs in Canada as well. So the fact that the Fed is also about to cut interest rates and there's a question there about how quickly and how fast and how much they do, those are leading to lower borrowing costs in Canada and they are kind of helping the Bank of Canada even though the governor says that he's going to set policy on his own. 

AL: So going back to the Canadian economy, Governor Macklem obviously talked about the risks to inflation on both sides, the risk that inflation could tick back up, but also that the economy could be too weak and inflation falls too much. Can you just walk us a bit through those risks in the current state of the economy right now?

JFP: Yeah, I mean, let's talk about upside risks to inflation first. And those really centre around a couple of things. We know, for instance, that wage gains have been pretty strong. Economy wide they've been more rapid than inflation and they've been significantly more rapid than productivity is. Productivity has actually been falling. So that wedge between wage gains and productivity is making it difficult for firms to kind of slow the pace of inflation because they're dealing with significant input cost pressures. So that's an upside risk to inflation. It’s very clear. There's a question of how real that upside risk is, but there's no question that's an upside risk of inflation. The other dimension on that is and we see this a little bit in the service space, which is where we're seeing a bit less disinflationary pressure on the service side is, the service economy is a much more labour dependent than the goods economy. So those kind of wage pressures are leading to probably a bit more resilience on the pricing side, on the service side of the economy than the goods side. So that's a concern. And the governor talked about that. He said ‘So listen, I'm looking at services. I'm a little bit worried about what I see there, not as much kind of downward pressure as we'd like.’ And of course, as part of the service side of economy, you've got the housing dimension. So rents have been going up. Cost of housing is not really going down. So there's kind of an upward pressure from that side as well. Now, the flip side of that is the economy is slowing —  and with that slower growth, that more importantly slower than potential growth — so we're creating what we call excess supply in the economy. So the economy is operating below its capacity. That's putting a bit of downward pressure on prices. And you're seeing that particularly on the goods side of the economy. So some downward pressure there, which is of course, part of the reason inflation has been coming down. Now, in terms of kind of the economic environment, well, it's not it's not super strong and it's a good thing that it's not super strong. I mean, the Bank of Canada had been raising interest rates to generate some weakness in the economy. The surprise has been the resilience of the economy so far to those rate increases. And we've gotten to a point where the economy's not struggling, but it's reflecting the impact of these past rate increases. And that's slower growth. But even within that, you're seeing you're seeing some surprises. You see, for instance, again, the continued impact of population growth, which is really, really strong. Most recent population growth numbers for the month of July are like record population strength, like the strongest population increase in our history, as opposed to an expectation that population will slow this year. It's accelerated. That's more households, more consumers, more workers, more people looking for rental apartments, for homes. And you've had, in particular over the last quarter, because we now have GDP data for the second quarter of the year, which was a little bit stronger than expected, but a little bit stronger than expected because government spending was really strong and government spending was really strong at all levels of government. So this is not a federal government issue. It's federal, provincial and municipal, actually largely municipal in this case, that gave retroactive wage increases to their employees as part of labour negotiations. And we see this particularly in the health sector, particularly education sector. So that created this big bump up in government spending, which supported growth in the second quarter. But  that's not really kind of private sector activity, right. That's just kind of government support that is distorting the picture a little bit. So the economy is a bit weaker than what we'd assessed just based on GDP numbers in the second quarter. And the governor reflected on that as well, he said, ‘Listen, things are softening. I'm not unhappy with that, but that's the result of what they been trying to achieve.’ 

AL: For sure, but following up on the GDP numbers, the per capita and household spending is quite lackluster as well. Is that something to be concerned about? We’re obviously looking for this ever-elusive soft landing, like is that something we should be concerned about?

JFP: I mean, people are concerned about but I'm not all that concerned about it. Because the reality is that population growth is effectively designed in a way to reduce GDP per capita or reduce consumption per capita. You think of the large number of temporary residents that are coming into the country, large number of students, a large number of low wage workers who are coming into the country to fill jobs at the low wage end of the job spectrum. Well, that by definition is going to reduce your GDP per capita, right? You're bringing in people who are working less than folks who are already here. So it looks like individually we’re all producing less. But that's not really true. You've got Canadians who are producing just as much, hopefully, and then you have others who you know are coming here to study, who are working less hours, who are less productive, maybe temporarily so. So it's not a surprise that GDP per capita is falling. It's a surprise that it's been like an ongoing process for several quarters now. But that's linked to this incredible surprise on the population side where we've just added so many people to the country. And then the same is true on the consumption side, right. You can think of consumption per capita as reflecting that that behaviour, same thing. But on the other hand, if you're thinking about consumption in general, you have way more consumers now than we did a couple of years ago because we have way more people in the country. So consumption is actually stronger. It just looks diluted when you look at it in terms of the number of people in the country. 

AL: I also want to take a deeper dive looking at employment numbers. Unemployment is at 6.4%. Yes, it held steady last month, but that's still relatively high. Is that potentially going to go up even higher? How do we sort of look at that as a risk factor?

JFP: I mean, it's probably going to up a little bit higher. Again, as the central bank’s efforts to slow the economy filter through, they occur with a lag. So we're still feeling the impacts of higher interest rates and we're going to feel them for a little bit still, maybe a couple of quarters, maybe three. The labour market is kind of a lagging indicator, so it reflects those economic developments with a bit of a lag relative to other parts of the economy. So we should expect a little bit more of an increase in unemployment rate. Now, what's been surprising, though, is that unemployment rate is up about a percentage point relative to where it was last year. So that's a reasonably big increase. But that's occurring not so much because firms are laying people off. It's occurring in large part because we've accommodated so many new entrants into the economy because of population growth and immigration, that those folks are looking for work and they're unemployed. Not all of them, but some of them are unemployed. So, it's creating an upward drift in unemployed people. But it's not the usual, you know, businesses are laying people off and that's creating the source of the unemployment. It’s just you have a much bigger labour force, many more people in the country looking for work, and that's pushing the unemployment rate up. So even that kind of unemployment rate dynamic is a little bit different than in history because it's not it's not necessarily the result of higher interest rates, it's more a result of we have a lot of people in the country, a lot more people in the country than were a year ago, two years ago. And those folks are looking for work and that's not happening instantaneously. 

AL: I also wanted to pivot to look at trade tensions. We've talked about how trade tensions in the past have obviously had an impact on inflation. And more recently, the federal government introduced some tariffs on electric vehicles, aluminum and steel from China. How does that factor into the central bank's future decision making as those potentially take effect?

JFP: So, they can't be very prospective about that. So they can be very forward looking about that. Trade measures are what we call supply shocks. So if you put a tariff on something, that's not a result of monetary policy acting. It's not a result of the economy being stronger or weaker that's generating these price pressures. It's somebody has decided you're going to pay more for steel, somebody decided you’re going to pay more for electric vehicles. So that's kind of a supply measure. And of course, that's inflationary. You're mandating that the price of whatever it is is going to be higher. Now, the extent to which it’s inflationary is questionable. The reality is on electric vehicles, we’re hardly importing any from China or maybe not even any from China, so this is more kind of a pre-emptive measure at not allowing those vehicles to come in. Chinese steel is being imported. So that's probably a bit of an inflationary thing there. But the bigger picture, I think, is one which links to inflation risks in general, which I didn't talk about earlier on in session, is there still is some tension on the supply chain side. Right. We still have some issues in the Middle East which are leading to very significant shipping delays. We've seen a very significant increase in the cost of shipping goods.  In addition to some China measures over the last couple of weeks in Canada and a little bit longer that in the U.S.. There still is a U.S. election out there with a former President Trump with a very protectionist trade platform. So if he were to win and kind of acts on the tariffs that he wants to put on, that's kind of inflationary as well and creates a bit of a kind of a weird kind of macro situation. So there is there is a lot to monitor on that side. We'll have a lot more clarity on that in the next couple of months. But right now it's more of a risk than something that the governor should be thinking very actively about and kind of counteracting in any way with his policy stance. 

AL: For sure, a lot to consider there. So before we wrap up here, what do you think are the three main takeaways for Canadians from this announcement?

JFP: Well, it's a continuation of what we've been discussing for a little while now. So it's clear that rates are on their way down and this is another confirmation that we should expect rates to continue to go down further. That's good news. It's particularly good news for borrowers. We have greater clarity that the economy is not falling off a precipice, that we are increasingly confident then that we're in a soft landing zone. So growth has slowed, but not overly dramatically. So that's, again, good news for Canadians. And we know, or at least we expect that, as rates come down and they filter through the economy with a bit of a lag, that those parts of the economy that have been impacted by higher interest rates will see some relief and should see a bit of a turnaround. So we're talking about housing, auto sales, home building supplies, renovation activity. Those are the things that we would expect to pick up in the next several months as Canadians benefit from lower interest rates. 

AL: Thank you, JF for coming back on the show and breaking this all down for us.

JFP: Thank you very much. 

AL: I've been speaking with Jean-François Perrault, the Chief Economist at Scotiabank.