- After three consecutive 25 basis points (bps) cuts earlier this year and a 50 bps cut in October, the Bank of Canada (BoC) closed the year with another 50 bps cut to 3.25% in December.
- We think the BoC will continue to cut interest rates through 2025 but there could be some variability on the timing and the path of future cuts. We think potential tariffs from the incoming U.S. administration may make inflation and the growth outlook uncertain. Recent announcements on slowing immigration could also affect growth while its potential impact on the labour market and wages remains unclear.
- Current interest rates are still higher than inflation and with Canada’s GDP growth remaining weak, there is room for the BoC to continue normalizing rates.
- Recent data prints show that while inflation continues to moderate, there is some noise in the data. October consumer price inflation (CPI) came in slightly above expectations at 2.0% year over year (y/y) (versus 1.9% y/y expected), after a very weak September print brought Q3 average CPI to the BoC’s 2.0% target. But shelter costs continued to moderate from +5% y/y in September to +4.8% y/y in October. The beat was not sufficient to change BoC’s overall trajectory.
- November jobs data surprised to the upside with 50,000 jobs added, twice the consensus expectations. However, this was more than offset by an increase in labour force participation that pushed unemployment up 0.3% to 6.8%. Hours worked declined 0.2% month over month and wage growth of permanent employees slowed to 3.9% y/y. On the margin, the BoC looked through the strong headline and put more weight to the increase in labour market slack.
- Real gross domestic product (GDP) grew 0.3% in Q3, after two quarters of +0.5% growth. Contribution from higher household and government spending were offset by slower non-farm inventory growth, lower business capital investment and lower exports. GDP per capita fell 0.4%, marking the sixth consecutive quarterly decline.
- While the BoC has a single official mandate of flexible inflation targeting, the renewed framework for 2022-2026 outlined how the BoC would “consider a broader range of labour market indicators to actively seek the level of maximum sustainable employment needed to keep inflation on target.” BoC Governor Tiff Macklem recently said that as the BoC approaches the inflation target, he becomes more concerned about downside risks.
- According to the BoC’s Q3 Business Outlook Survey, firms say high rates continue to weigh on consumers. Q3 sales expectations are still below average and all three categories (business activity, prices and costs, and capacity) remain negative albeit less so than in Q2. We think Q3’s figures improved over Q2 due to consecutive interest rate cuts from the BoC.
- The BoC’s Q3 Consumer Expectations Survey has showed consumer perception and expectations of inflation declined from Q2 but still hovers above pre-COVID levels. However, expectations for inflation two years from now declined sharply from Q2 and are now at pre-pandemic levels. On the positive side, indicators of perceived financial stress (i.e. expect finances to decline over the next year, probability of job loss) improved, reversing the sharp deterioration in Q2. About 44% of consumers surveyed have noticed the impact of interest rate cuts. However, high prices and elevated interest rates continue to weigh on consumer budgets.
- Overall, both surveys indicate that high interest rates have brought inflation back towards target and there’s room to further loosen restrictive financial conditions.
- There were several significant data points that influenced this decision. The all-important GDP for Q3 2024 came in at 1%, which was slightly below consensus expectations of 1.1%. The details were mixed, although on balance the report pointed to a broadly softening economy.
- On the inflation front, the latest report saw headline inflation reaccelerating to 2% in October (vs. 1.6% in September), which was slightly above consensus expectations. The BoC’s preferred core measures (CPI-median and -trim) also surprised to the upside. Nevertheless, these prints remained within the 1% to 3% target range.
- While we are happy to see that headline consumer price inflation (CPI) inflation has tracked 2% and core inflation measures have stabilized around 2.5%, the weaker GDP prints concern us. Headline CPI in October returned to 2% after a drop the previous month. While anticipated, it was a bit above expectations.
- The weakening Canadian dollar (CA$) could also hinder the BoC’s task of getting inflation back to target. Recent results however show that Q4 GDP is tracking below the BoC’s estimates forecast in the October Monetary Policy Report.
- In addition, president-elect Trump’s U.S. election win brings policy uncertainty. Notably his threat to levy a 25% tariff on Canadian imports could hamper growth further.
- We think the BoC will keep a close eye on the housing market as 2025-2026 brings on large mortgage maturities and the benefits of super low interest rates end. As a wave of mortgages reset at relatively higher rates, a faster move to neutral could be warranted.
Source: Statistics Canada, Macrobond
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