Andrew Pyle
March 07, 2024
What if we don't get to 2%?
It wasn’t long ago that investors were keyed up for central banks in both Canada and the U.S. to start providing interest rate relief before the first quarter was over. At the policy meetings in January and followed by comments made by BoC and Fed officials, cold water was poured all over that idea. Most have now moved on to casting their binoculars towards a summer rate cut horizon and this week’s BoC meeting reinforced that.
There was no expectation that the Bank would change its overnight rate target from 5%. Few suspected that there would be guidance embedded in the language of the meeting statement that this “pause” was about to be over. Well, no one was surprised. The rate was left at 5%, which is not good news for prime+ borrowers. While the Bank acknowledged that economic activity is cooling down, and wage growth is off the boil, it stopped at suggesting that a pivot to lower rates was going to happen at the next meeting, which takes place on April 10th.
That is only four weeks away, so it is extremely doubtful that information would emerge between now and then that would see the Bank’s first easing move in four years. If not, then the next opportunity is on June 5th. While the Bank did highlight the fact that the economy is growing below its potential rate and that employment is expanding at a cooler pace, what stood out in the statement was the reference to shelter costs and how core consumer price inflation is holding in the 3-3.5% area. In addition, the Bank commented on how the number of components that are rising by more than 3% is still above the historical average for Canada, even if the number has come down a bit.
Since the Bank expects that inflation will remain close to 3% for the remainder of the first half, even though it dipped to 2.9% in January, there is no way it can provide guidance to a lowering of rates. The counter argument to this is that central banks should set policy in a forward-looking manner. In other words, even if inflation is not back to the 2% target, if the Bank predicts it will get to that level over the next 6 to 12 months, then it should start adjusting rates so that it doesn’t overshoot and push the economy into recession.
The problem is that the Bank has acknowledged, along with most everyone else, that the easy work on bringing inflation down is behind us and the last percent is proving hard to achieve, given the stickiness in areas like shelter. It also knows that if it takes the foot off the brake pedal now, that could re-ignite demand and potentially push inflation higher.
In previous commentaries, we have looked at consensus GDP forecasts produced by Bloomberg, but they also survey economists on inflation. This takes place every month and then the average forecast is compiled so that we can track it. The above chart shows the average forecasts for Canadian inflation in 2024 and in 2025. In both cases, there has been little to no improvement in predictions in terms of expectations of lower inflation over the past few months. Economists still expect that average inflation for this year will be around 2.5%, compared to a year ago when the 2024 consensus was closer to 2.2%.
If inflation did continue to decline over the course of this year, down to say 2%, then this consensus call would be correct. As you can see, the 2025 forecast is still close to 2%, though it has edged up to 2.1% in recent surveys. With only one month of data, it is difficult to place a high probability on this outcome, but we will get three more CPI reports before the Bank meets in June and if inflation has fallen to around 2.5%, then 2024 consensus will look more believable. Six months from then takes us to year-end and if the 2% target looks likely to be achieved at that point, then the Bank will have more confidence to begin the easing process. That doesn’t necessarily mean it starts that process in June, but markets will start to price that in if indeed inflation trends towards 2.5%.
The question would be whether the Bank would cut rates with a headline inflation that is trending to 2%, if core inflation remains at 3% or above? Based on what we heard from the Bank this week, it seems as though they believe that won’t be the case, given the slowdown in wage growth and the declining number of components that are tracking at 3%.
That said, the statement suggests that if there is no further progress in core inflation then the Bank is perfectly happy leaving rates where they are. This is one of the reasons why the downward move in Canadian bond yields has lost momentum this week. Of course, much will depend on tomorrow’s February employment reports for both Canada and the U.S. If you recall, the January numbers came in much hotter than economists expected (at least for the U.S.) and predictions again are for cooler growth. Assuming economists get it right this time, then the rally in bonds that we have seen over the past few weeks could continue. Delays in rate cuts aside, Ally and I remain bullish overall on bonds for the rest of the year and see the yield lows of December being re-tested and taken out before year-end.
On behalf of the Pyle Wealth Advisory team, have a wonderful week.
Andrew Pyle
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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle] do not necessarily reflect those of CIBC World Markets Inc.
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