Stephen Meurice: On Wednesday the Bank of Canada held its key interest rate steady at 5%. Another rate hike seemed possible as recently as a week ago. But that was before Statistics Canada announced that the Canadian economy actually shrank in the second quarter. So today Scotiabank Chief Economist Jean-François Perrault is back. He’ll talk with Perspectives’ Armina Ligaya about the Bank of Canada’s latest decision, what it means for the economy and households, and whether this signals the end, finally, for hikes that have seen interest rates soar to a 22-year high.
I’m Stephen Meurice and welcome to another season of Perspectives. Now, here’s Armina Ligaya.
Armina Ligaya: JF, welcome back, as always.
Jean-François Perrault: Well, thank you.
AL: So the Bank of Canada, as expected, held the rates. What's your main takeaway from the announcement on Wednesday?
JFP: You know, reading the communique, it sounds like they're a little bit confused about what to do. On the one hand, they point to economic activity being quite a bit weaker than they had expected and that we all expected, and there are some temporary factors to that that are kind of clouding the picture a little bit. But, you know, they have been trying to slow the economy for quite a while. So this was in a sense, really good news, like things were slowing. So they referenced that. And that obviously featured very prominently in the decision not to raise interest rates, but they balance that with some pretty concerning statements about where inflation is. You know, they say core inflation is in the three and a half percent range. That's too high. They need to be vigilant. They point to rising wages and a whole bunch of factors that are pushing it up and are very explicit, they say we will need to raise interest rates further if this doesn't change. So that's a little bit of good news, bad news. Happy with where growth is, not happy with inflation right now. The growth thing is outweighing concerns about inflation, but that might not be the case next time we meet.
AL: Definitely. So, obviously homeowners and businesses are breathing a sigh of relief that this is the move that they took. But with all that in context, do you think it was the right move to pause?
JFP: I think so. I mean, inflation has picked up over the summer. There's no question about it. It might be a temporary blip. Might not be. You need a little bit more information about where inflation is to be sure that you need to pull the trigger once more because we know that rates are having an impact now. And the question is like, do you need to cause even more damage than you've already got in the pipeline if you're not sure about where inflation is going to land? So we have, for instance, we'll have some labour market information pretty soon. We'll have a couple more inflation prints by the time they make their next decision. So there'll be a lot more information about allowing us and them to assess the kind of the true dynamics of inflation, which should give us a pretty good sense and them a pretty good sense as to whether or not they've set policy at the right level or whether they do a little bit more or maybe they've done too much. It's not likely the case, but...
AL: So the Bank of Canada has paused once before and picked up again. How long do you think this pause will last?
JFP: Well, we're hopeful that it lasts to the spring. So we're hopeful that this is the last interest rate increase and then the next one will be a cut. Now, that is, of course, a function of will inflation fall further? How will the economy respond to the rate increases that they have done in the past? Are we in for more dramatic or less dramatic slowing? So all the things are going to are going to impact on, you know, when and how fast the Bank of Canada is going to cut. But at present, I mean, if forecasts materialize, inflation continues to decline gradually, if the economy continues to slow, gradually, then we're probably at the end of the line for the rate increases. And we're just looking to when they start cutting.
AL: So I'm sure that that's the announcement that many people are looking out for. You were saying you were hoping it would be a cut sort of next year. When's the earliest realistically we might be able to see one?
JFP: Late spring, I think, might be the earliest. Early summer, late spring.
AL: The pause was prompted largely because of a slowdown in Canada's economy, but for the last quarter, was that slowdown or surprise contraction a blip with wildfires and other factors, or is this an actual material evidence that the central bank’s moves are working?
JFP: It's a little bit of both. We know, for instance, the domestic demand. So these are basically consumption, investment, government spending, things that are much more a function of what's going on domestically as opposed to internationally. We know that that rose by a percent. So it's not all bad. I mean, there is solid evidence that the economy is still hanging in there. But then again, there were like massive wildfires, there were severe interruptions in mining activity. Things that we know are going to be temporary. They might have a bit of the long breath in them because obviously we had wildfires in in July and August and strikes in July and other things that are impacting and clouding the outlook. But it does look like the economy had slowed or was slowing a little bit. But you know, what really tripped it into negative territory were like these one-off freak accidents, if you will, that are not likely be replicated. But we're still dealing some of those or we were dealing some of those as of a couple of weeks ago.
AL: And so then there's the other dynamic in the economy that everyone's watching for expecting, which is recession. And so what does all of this mean in terms of recession?
JFP: You know, it's a good question. We had been forecasting a slowdown of some sort, a mild recession, soft landing, stall. Call it what you will. And, you know, one of the one of the definitions for a recession is two quarters of negative growth. Now we have one quarter of negative growth. So, you could argue that we're on track to having a recession if we get a repeat of that in the third quarter. That's probably not likely, again, because some of these temporary factors kind of messed up the second quarter. But we do know that the economy is slowing and is slowing gradually and doesn't seem to be crash landing. We're not looking at a dramatic pickup in unemployment rates or masses of layoffs. None of that is occurring right now. And you know, those are kind of the necessary conditions to have a meaningful recession. And that honestly doesn't seem to be the case. You know, when we look at the U.S., for instance, where U.S. economic activity matters a lot for us, they're having like a gangbuster quarter where growth is far, far, far exceeding expectations. So even the international environment is helping to some extent insulate us from a bad outcome. And then you layer on top of that, which is a reasonably recent development: a very significant pick up in oil prices. Which make the inflation problem worse, but for Canada, do add economic activity. So it doesn't look likely that we're going to have a bad recession, but we need to have a slowdown, and that's the path that we're on. So we're comforted by everything that has been happening.
AL: I wanted to delve into where we are at currently in terms of inflation after ten interest rate hikes since last March. Where are we at in terms of inflation and where do we go from here?
JFP: Yeah, so inflation, picked back up a little bit in the most recent observation. So it was 3.3%. That's total inflation. That includes the impact of energy and food prices. When you strip those out, and it's important to strip those out because like these volatile movements in commodity prices, food and energy, that's not something the Bank of Canada can really do something about. Obviously, they matter for households. They matter for you and me, because it matters from our finance perspective. But it's very difficult for the Bank of Canada to impact those. So they look at things like core measures of inflation, and those are things that are kind of much more stable, like they're heavier things to move, but they're also things the Bank of Canada can move. And that's been in the kind of 3.5% to 4%, a little bit more than 4%, range last few months. So it's kind of stalled at a level which is uncomfortably high. Now again, the Bank of Canada target is two. And there's a range of one to three around that the headline number is just barely above. In fact, we were below three in the month before that. Whereas these core measures inflation, which are again the things that the Bank of Canada really cares about, they're still uncomfortably outside that 1% to 3% range.
AL: You recently put out a report which said that interest rate hikes have reduced inflation by 0.6 of a percentage point so far. Now, given that we had inflation that peaked at 8.1%, that doesn't really sound like a lot of gain for so much pain. But you made the case in the report that it's actually significant. Could you explain that a bit more?
JFP: Yeah, I mean, you've got to keep in mind that the movements in inflation that we've seen over the last few years, they're enormous. You know, pre-pandemic times, you'd be worried about inflation if it was like 1.7% or 2.3%, and you'd move policy on that basis to try and make sure that inflation lands at 2%. So, sure, inflation was over eight, it's now slightly over three, a five-percentage point decline in these kind of headline numbers’ policies had a reasonably little impact in the greater scheme of things. But when you put that 0.6% in context of the typical impacts of monetary policy on inflation, the typical movements you see that are driven by central bankers, 0.6 is actually very, very, very large. So it is a meaningful contribution to what's happened on the inflation front. It's just that there are all these other things that are going on at the same time that are also having a significant impact on inflation dynamics.
AL: So for households, businesses, borrowers of any kind, progress is being made, but, you know, real time, they're still feeling the pinch. What's the takeaway for them out of this latest announcement?
JFP: Well, they can be a little bit hopeful that, you know, the bank, at least as it's looking at incoming data, feel like they can take a chance and not move rates now. And maybe this is a signal that they're done. So for those that are worried that rates have got to go up a little bit more or a lot more, there is there is a kind of a positive sign here. Now, that being said, we do have to be mindful of the fact that and this inflation issue is not solved. And if anything, the risks between now, and say, the end of the year are that the Bank aims to do more. So we're not out of the woods by any stretch of the imagination. But the fact that the economy is slowing, as much as that might be painful for businesses and households, I mean, there are people that are losing their jobs. Their businesses are going to go bankrupt. Insolvencies are rising. Like there is pain that's going on. Unfortunately, that's kind of a necessary adjustment that's required to bring inflation down. So that very bad news for some individuals, some companies is actually good news for the rest of us.
AL: JF, thanks as always for taking the time to break down this latest decision for us.
JFP: You're very welcome.
AL: I’ve been speaking with Jean-François Perrault, the Chief Economist at Scotiabank. The Perspectives podcast is made by me, Armina Ligaya, Stephen Meurice and our producer Andrew Norton.
