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The Bank of Canada surprised many with a smaller-than-expected rate hike of just 50 basis points. Scotiabank’s Chief Economist Jean-François Perrault is back on the podcast to break down what this means and what the central bank is signaling about inflation and the economy ahead.   

Key moments this episode:
00:48 — First reactions: why this move is surprising and what it could signal
2:08 — How did we end up at this high of an interest rate?
3:05 — What impact will these rising interest rates have on daily life?
5:15 — Has employment been affected by interest rate increases?
6:35 — What is a monetary policy report and what did it say?
8:33 — What is a ‘technical recession’?
10:15 — What would a ‘technical recession’ mean for Canadians?

 

Transcript:

Stephen Meurice: This morning, the Bank of Canada took another step in its fight against decades-high inflation.

[sound bite from the Bank of Canada news conference ]

Tiff Macklem: Today we raised the policy interest rate by 50 basis points to 3.75%. This is the sixth consecutive increase since March.

SM: That’s Tiff Macklem, the Governor of the Bank of Canada during a news conference earlier today. As you heard, the Central Bank’s benchmark interest rate now sits at 3.75% It hasn’t been that high since 2008.

To help us break down this move and what it might mean, we’re joined as always by Scotiabank’s Chief Economist, Jean-François Perrault. I’m Stephen Meurice and this is Perspectives.

JF, welcome back to the show.

Jean-François Perrault: Well, thank you.

SM: So, what's your first reaction to today's news? Are you surprised?

JFP: A little bit surprised. I mean we had anticipated a 75-basis-point move, the market had anticipated a 75 basis-point move. They moved by 50 basis points, so that's a bit of a negative shock. But, you know, maybe at the end of the day this is a positive thing.

SM: A negative shock in what way?

JFP: Well, in the sense that they did less than what the market had anticipated, right? So, they moved by 50 basis points. We were anticipating 75. Now, clearly it means that they believe that there's less pressure for them to raise interest rates than we did. So perhaps that means that we are nearing, rapidly nearing, the end of the tightening cycle, which would be a great thing if we managed to get out of this with another move in December. So, it's upsetting, if you will, in the sense that they didn't do what it is that everybody thought they were gonna do, but it's good news in the sense that perhaps, we're getting near the end of the road.

SM: So, should people take some comfort from that?

JFP: I think so. Our interpretation is that it means that the Bank of Canada is more comfortable with the inflation outlook, it’s more comfortable with how data is coming in, in terms of how they need to think about interest rate policy. So instead of being in a rush and still needing to do a big move of 75, they're looking at the sum of the information they've got available to them. They're thinking that they can take a little bit more time. They can go by 50, possibly 50 another time, and then be done, at least that's our interpretation at this point, this early point.

SM: Right. So, the bank didn't raise as aggressively as many expected, but still I think no one, not economists like yourself nor the Bank of Canada, thought that we'd be at even at this high of a rate by the end of this year. Can you tell us what got us here? Take us through some of the factors that made these continued interest rate increases necessary.

JFP: The underlying reason is quite simple and that is inflation has not behaved as central banks had wanted to. Remember, the Bank of Canada has a 2% inflation target, inflation is close to 7% now. It was as high as 8% earlier this year. So, it's coming down because oil prices have come down. But throughout the year, inflation has essentially been on the rise and moving farther and farther away from the target. And that's required a more and more aggressive stance of monetary policy to try and break that down. Now, the reasons underlying the rise in inflation are reasonably complex, but fundamentally that's what the challenge has been. Poor inflation control means a more aggressive attempt to control inflation.

SM: Right. And I think everybody's aware of the impact of inflation every time they spend any money. But what are the adverse effects of these rising interest rates? I mean, what can people expect to see in the coming months? What impact is it having, both on the economy and on the daily lives of Canadians?

JFP: So, folks obviously think of it in terms of adverse effects. You raise interest rates, it hurts. The Bank of Canada would say that's how it's supposed to happen. So, they don't think of these as adverse effects. They think of the impacts of higher interest rates as what is necessary to achieve their inflation objective. But those impacts are pretty straightforward, right. So, you raise the policy rate for the Bank of Canada, it has an impact on prime. It has an impact on a broad range of interest rates, meaning that any interest product or a product in which you pay interest. Well, not everyone, but some of them are fixed, but the vast majority of products are costing more, so higher mortgage rates, higher mortgage payments, the cost of the auto loans and lines of credits have been rising. So that takes a bite out of household spending. There's no question about it. But again, that's the intention. They're doing this to try and slow spending, to encourage people to save. Now some of the unintended consequences are, well, when you raise interest rates, you know that things are going slow, but you don't know exactly how fast it's going to happen. So we've seen, for instance, a very big reaction in housing markets. Now, housing markets needed to slow. This isn't necessarily a bad thing, but the speed at which it's happened is probably a little bit surprising. So, a bit of an unintended consequence, if you will, or I'm not sure the Bank of Canada thinks of if this way, but certainly that's how we think about it. But in line with what we would have expected. Slower pace of sales, falling prices because rates are on the rise.

SM: Okay.

JFP: And the final kind of consideration here is that people are sensitive about these things, right? You raise interest rates. Historically, it's been associated with the recession, so it generates a set of fears and concerns on the part of households, on the part of firms that come into play as well, right? If you're worried about the outlook, if you're worried about the interest rate path going forward, perhaps you save a little bit more, perhaps you spend a little bit less, perhaps you were more worried than you should be. But these things matter in terms of how people think about their financial situation and ultimately impact their behaviour.

SM: So, we talked about a recession a little bit and we'll get into that a bit more. But it seems like the employment situation may indeed be starting to be affected by all of this, by interest rate increases and so on. I saw one report saying there are about 100,000 fewer jobs in Canada between May and September. Should we expect more of that? Is that a direct impact of these policy decisions that are being made?

JFP: It's certainly a direct impact. I mean again, the bank is raising interest rates to slow economic activity and you can't really slow economic activity unless you slow employment growth. Now there has been some adjustment in the labour market already. It's pretty minor, you know roughly 100,000. Some of that's in the real estate sector, which of course is slowing a lot. We know that. Some of that's the construction sector, some of that is just kind of the result of kind of wage bargaining between teachers and unions that lead to some temporary disruptions in the employment flow. But I would characterize the labour market over the last several months as pretty stable. We're not creating that much more jobs and we're certainly not losing that many more jobs. And despite this dynamic, the labour market remains unbelievably tight. It's a challenge for workers, it's a challenge for employers and if it's challenge for employers, it remains a concern for the Bank of Canada. In fact, they talked about that today in their Monetary Policy Report. Not everybody, but a lot of firms are still complaining about how difficult it is to hire and to retain workers, and that again, it's got an impact on wages. It's got an impact on inflation going forward. It's got an impact on a broad range of things.

SM: So you mentioned the bank's Monetary Policy Report, which they released today, along with their rate announcement. Can you tell us what that is and what are the important messages that you glean from that?

JFP: So the Monetary Policy Report comes with the statement by the bank of Canada in terms of their policy attention, and that's basically an articulation of their views about the economy. Their views on where inflation is gonna go, their view where the economy’s gonna go, how they think about the global economy. So, it's a very, very informative, a very impactful articulation of views to help folks like us understand how the Bank of Canada is thinking about the world and therefore how it might think about interest rates. And in this report that basically talked about the growth forecasts. So, reasonably strong growth this year, things are slowing. The expected growth of about 1%, slightly less than 1% next year and inflation going back to target sometime in 2024. And that's, you know, there's a lot of stuff around that, but that's kind of the gist of the report which, of course, you know, we look at and compare that to our own forecast. See if it makes sense, see if we want to adjust how we think about things, see if we want to adjust our interest rate forecast. Roughly speaking, it seems like their views are pretty well aligned with ours and that's comforting from our perspective. So it gives us some sense that our view that interest rates in Canada say, will peak at 4.25% at the end of the year remains reasonably well-founded. So it's, you know, it's a helpful report in a number of different perspectives.

SM: Is that 1% growth next year, surprising? That is down from what from their last projection that I believe?

JFP: I mean, everybody's been revising forecasts down. Like the reality is the external environment is not good. Like China's having a hard time. Europe's gonna be in recession, the U.S. is gonna tighten more than anybody thought. So that's gonna mean a weaker U.S. So the headwinds facing Canada are pretty formidable. So, it's fully expected that they were going to reduce their forecast. We've actually got a little bit less growth than that. We're kind of in the in the 0.6%, 0.7% range as opposed to the close to 1%. But again, it's a reflection of those same factors. Like, the world outside of Canada is a much scarier place than it was several weeks ago.

SM: So 0.6 or even 1% starts to feel, especially if you build in some kind of margin of error, starts to feel pretty close to 0 or pretty close to contraction. In your last global outlook, I think you said you expect a short technical recession in 2023. Can you explain what a technical recession is versus a regular one?

JFP: Yeah. So technical recession is just a shorthand for saying two quarters of consecutive declines in economic activity. Now, the official definition of recession involves a lot more than that. Looks at employment, looks at a range of other economic data, but those come in with a lag. So, if you get two quarters negative growth folks often call out a technical recession. Now that could be a -0.1, two quarters of -0.1. Or it could be two quarters of minus 10. Now we're in the view that it's closer to -0.1. So a very shallow decline in economic activity, more akin to a stall. So it's not really a dramatic reversal in economic fortunes. It's just you're hitting a bit of a soft patch. Things are kind of stable. A little bit negative, maybe a little bit positive. We'll see. When you’re bouncing around zero, it doesn't really matter whether it's plus 0.1 or minus 0.11, but we're thinking it more in terms of a stall. That we've kind of been slowing, have a bit of a break in economic activity. Well, a welcome break. I mean this needs to happen and then a resumption of economic activity going forward because of course the flip side of this is if things don't slow, inflation doesn't slow.

SM: Right.

JFP: And the Bank of Canada has got to do more, so there's going to be a slowing at some point. So, we're not, you know, looking at this as evidence that things are turning, like this is a very harmful and damaging and unwelcome development. This actually needs to happen.

SM: It's the whole point of the interest rate increases. If employment is strong and we expect it to remain strong for the reasons that you mentioned. What does a recession then actually mean to Canadians? If it's likely, they'll probably still have a job. What are the impacts?

JFP: Well, historically this is the concern with recessions, right? When they are hard and they're deep, you get layoffs, so you get bankruptcies. You get a big economic adjustment that takes place. When you're looking at something much more modest, those impacts are muted. Like we know, for instance, that the labour market is very, very tight. There's over a million vacancies. There's a lot of slack there for firms to be able to shed vacant positions before they actually need to cut employment. Because we know that firms, for instance, have been having a hard time filling vacancies, retaining workers over last year, a year and a half. So, that’s the number one challenge for firms. So, as we think about it, the fact that the labour market remains really tight, the fact that firms are still crying out for workers probably means that when we go through this soft patch that they're going to hold onto workers much more so than they would have over history. They'd hoard labour. And therefore, that mutes the employment response and it mutes the impact on households. And so, you know, that's I think from a worker perspective, the most probably the most important thing. That the expected job losses that we would see in a mild recession are probably quite low by historical standards. Because this labour market is as dynamic as it is, so much more job security.

SM: Right. So, if there's job security, then mostly what people are gonna have to handle from personal finance perspective is the interest rates and the inflation. It's basically about managing the money that you do have.

JFP: Exactly. And I mean, that's how it should be. Now, people are always gonna be worried. It's one thing to say we don't expect many job losses, but the reality is when people are worried about recession, they worry about losing their jobs no matter what you might say is the strength of the labour market. You know, there's a riskier environment and of course you internalize that. So, you add that into the factors, but realistically it's probably not gonna be as worrisome of environment from a job security perspective as it would have been in any of the last recessions.

SM: OK. Well, on that reasonably optimistic note, we will leave it there. JF, thanks as always for your time.

JFP: Thank you.

SM: I've been speaking with Jean-François Perrault, chief economist at Scotiabank.