Hey Guys!
The Bank of Canada released notes related to their decision to raise the key lending rate by 0.25%.
Up until now, we’ve only ever had the formal press release and media scrum Q & A as insight into the BoC’s thinking.
Below is a breakdown of their deliberation notes, which provides insight into their near term thinking of future interest rate movements …
In general, the BoC is calling for the elusive “soft landing” which is a mild recession and a moderate slowing of the economy. And we might stick it. Maybe not though.
Honestly, I am hearing reasonable economic support of future rate drops, or future rate hikes. I remain open to the possibility of either scenario. As we exist the pandemic there is still a fair amount of economic turbulence to note.
With that said …
The BoC meeting deliberation topics of discussion were:
- International economy discussion.
- Domestic economic developments and inflation outlook.
- Considerations for monetary policy.
- The policy decision.
International Economy Discussion:
Close to a year ago, Russia invaded Ukraine which caused a spike in oil prices. Global oil prices, and the trickle down effects of higher prices, have eased.
- The BoC notes the “United States, the Euro area and China, was somewhat above the Bank’s expectations in the October Monetary Policy Report (MPR). Council members continued to expect a significant slowing in global growth in 2023 as pent-up demand fades and the effects of higher interest rates restrain activity.”
Essentially, the BoC is thinking the current level of interest rates will eventually seep further into the above economies and slow growth. - South of the border, “the U.S. consumers had been resilient, but growth is expected to be roughly flat in 2023. Inflation was coming down, largely due to lower energy prices, and signs of broader moderation in inflation were becoming evident.”
The U.S. economy has a lower debt-to-GDP ratio than Canada and is seemingly better insulated from higher interest rates. Their homeowners were locking into fixed rates in the 2-3% range—for 30 year terms. I’ve heard the U.S. refers to our 5-year fixed rates as long-term variable rates. It’s possible the U.S. economy is less responsive to higher rates than Canada. - One international risk to up-side inflationary pressure is, “the outlook for oil prices was subject to an upside risk because of China’s reopening. If Chinese demand were to rebound by more than anticipated, oil prices could rise substantially, putting renewed upside pressure on Canadian and global inflation.”
In this scenario, Alberta would be positioned well relative to other parts of Canada because we would see some benefit from higher oil prices.
Domestic Economy + Inflation Outlook:
- The overall economy saw positive and negative forces combine, “Canada’s gross domestic product (GDP) grew by 2.9% in the third quarter, stronger than the Bank had expected. Members noted that strength from commodity exports offset softer household spending, with outright declines in both consumption and housing activity.“
Again, AB is benefiting from our commodity exports, but we know that combined consumer spending is highly important to our overall economy—and that is slowing. - The careful balance of job loss and wage growth—both influence inflationary pressure. This is a delicate balance. The governing council notes, “Council concluded that wage momentum was plateauing in the range of 4% to 5%. Persistent wage growth in this range was not viewed as consistent with achieving the 2% inflation target unless productivity increases to well above its historical trend.
A possible outcome of continued wage pressure, and above expectation jobs reports, is the need for higher interest rates. Alternatively, if there is larger than normal job loss, from high rates arresting the economy, that is not welcome by the BoC. For now, the BoC seems content with wages plateauing and allowing the economy to adjust to current rate levels. - Governing council discussed inflationary data, “three-month annualized rates of inflation below the year-over-year rates for both total CPI inflation and, to a lesser extent, core measures of inflation.”
Near term measures of inflationary data is beginning to trend lower indicating evidence of higher rates seeping into the broader economy. - Some inflationary pressures are to remain sticky though, “services inflation was likely to be persistent and acknowledged that food and shelter inflation remained particularly high.”
The cost of food will fluctuate, the shrinkflation we are seeing is to remain permanent. - Governing council’s discussion on the inflation outlook, “CPI inflation was projected to decline to 3% in the middle of 2023, lower than projected in the October MPR. The decline largely reflected the fall in energy prices, weaker goods price inflation coming from slower demand, and supply chain improvements.
This is the BoC’s call—3% inflation by the summer? Let’s watch. - Further inflationary pressure easing in 2024, “the forecast that inflation would decline further in 2024, reaching the 2% target. They recognized that this would require services inflation to come down and that inflation expectations and growth in labour costs would need to moderate.”
If this, then that. If this happens, then that happens. Again, we’ve seen the BoC fumble the “inflation is transitory” call. The further out these kind of predictions are, the more I weight the uncertainty of the call.
Considerations For Monetary Policy:
The governing council debated several reasons for slower than projected consumption:
- Mortgage renewals. Approximately 20% of Mortgages renew each year. And clients are renewing into a higher interest rate environment, which a) can reduce their spending more than expected, b) encourage savings, c) weaken consumer confidence and d) put-off major purchases. Alternatively, savings rates were way up during the pandemic making which support consumption.
- The housing market is vulnerable to move in either direction. There is risk should house value declines accelerate (mostly outside of AB FYI). On the other side, immigration, household formation and anticipated monetary policy easing could spur housing activity to the upside.
- Labour market perspective. Governing council discussed reopening fading, the economy slowing and immigration adding to the labour supply over time. Rebalancing of the labour market might take longer as firms are still facing labour shortages, and an aging workforce declines.
- Risk of inflation remaining stuck above 2%. This could materialize from a) persistent supply chain challenges, b) service price inflation, c) wage growth, d) inflation expectations and e) higher oil prices.
The Policy Decision:
The monetary policy decision was framed around two dimensions:
- Leave the policy rate as-is or raise it by 0.25%.
- Maintain similar forward looking language, or adjust the language to signal a pause.
The decision was to raise the policy rate by 0.25% and clearly communicate a pause—based on future data.
Conclusions of this discussion where:
- The bar for future rate hikes is raised. If the economy unfolds broadly as projected, no further rate hikes would be needed.
- An accumulation of evidence is needed to raise rates again.
- Be clear about the conditions of this rate-hike-pause. The BoC will raise rates to achieve their 2% inflation target—if required.
Conclusion:
Did you skip to the bottom? I do to :-).
Our policy makers have given us more insight into their monetary policy deliberations, as noted above.
Rate hikes typically take 12-18 months to be full absorbed into the economy. The BoC’s rate hike storm started March 2022. There is still some time for the full effect of all cumulative rate hikes to be realized.
For many reasons, the Bank of Canada is now allowing some time for data to come back to make further rate hike-pause-cut assessments.
Variable rate Mortgage holders find respite is this pause. We all watch incoming data and adjust our interest rate outlook accordingly. For now, the BoC’s March interest rate announcement will be “no change”.
I hope some of this insight is helpful. If so, pass on this email and let me know.
Chat soon,
Chad Moore
