Stephen Meurice: The Bank of Canada announced Wednesday that it’s holding its key interest rate at 5%, the second consecutive hold for the bank. Does that mean relief is in sight for Canadian households who’ve seen the cost of borrowing – especially mortgage rates – balloon since the beginning of last year? And does it mean inflation is finally coming under control? Is a recession still in the cards as economic activity slows down?
Scotiabank Chief Economist Jean-François Perrault is back on the show to try to answer those questions and more. He’ll talk with Armina Ligaya from the Perspectives team about the Bank of Canada’s latest decision and what it means for Canadians.
I’m Stephen Meurice, and this is Perspectives. Now here’s Armina Ligaya.
Armina Ligaya: Welcome back, JF, as always.
Jean-François Perrault: Thank you. It's a pleasure to be here.
AL: So, the Bank of Canada, as expected, held the rate steady once again. I feel like we've had this conversation a few times [both laugh] but this time reading between the lines of the central bank's latest announcement, what's your main takeaway from the decision today?
JFP: It's basically been the same takeaway we've had for quite a while. The governor is a little bit unsure about where the economy is going to go, he’s a little bit unsure about where inflation is going to go. He knows that his rate increases have impacted the economy and he knows that. But he's also really unsure about where inflation is going to go. So, he's basically saying, ‘Listen, I'm stopping for the moment. I'm really mindful of where inflation is going and I may need to do more and I will do more if I need to do more.’ So, it's a bit of a mixed message, right? Some degree of comfort where things are now but indicating that he will not hesitate whatsoever to raise rates further if the need arises.
AL: I wanted to follow up on that last bit again about how he sort of put that line in the statement that sort of like, you know, things are going in the right direction, but I reserve the right to take more action if needed. Is that an indication that there would be more action or is that sort of a line that keeps people from or markets from jumping too quickly to what would be perceived as an indefinite hold?
JFP: It's a little bit of both. I mean, you know, clearly, if he were to go out there and say, “We're done,” then the focus then turns to, okay, when are they going to cut rates? Right. So it changes the psychology of markets, it change the psychology of individuals, right. If you're, thinking about making a major purchase that requires some debt and you know, you're now switching to, ‘Well, I'm less worried about where rates are going to go in the short run because I think they're going to be cut.’ That incents you to start to think about making those purchases. The governor wants to preclude that. He wants people to be fearful of and plan for a potential rate increase more than a potential rate cut. So that's pretty important in kind of line of reasoning he's got and he's not going to pull that statement for quite a while until he is sure that inflation is definitely on the right track and that they will eventually be cutting interest rates. And he's not sure about that yet.
AL: I'll come back later to the topic of rate cuts, because I'm sure everyone is watching closely for that. But let's go back into the reasoning behind today's decision. It was widely expected that they would hold, but even as recently as two weeks ago, there were some murmurs that maybe they wouldn't hold, maybe they would increase. So what was the data, what were the driving factors behind today's decision?
JFP: Yeah, so there's been a bit of a change in dynamics. If we go back to the last decision, so this is in early September, at that time, the governor said, listen, the economy slowing, I like that and he's saying that again now. He indicated some concern about inflation, as he has now, indicated that he would be needing to move rates if inflation didn’t come down. And shortly after that decision, we got inflation data for the month of August, which showed a very significant acceleration in inflation, significant enough that had he had that information the week before in the last decision, he probably would have had to raise interest rates. So, you had this surprise on the inflation side, which is really problematic in the middle of September, followed by a couple of employment reports that were really quite strong and showed really strong wage acceleration. So, you put those three things together and it kind of set the stage for a rate increase this week. Now, thankfully, last week we got September inflation data, which reversed a lot of the gains that we saw in August. And that was really helpful because it you know, I mean, obviously shows inflation is volatile, but it provided some degree of comfort that maybe we can wait a little bit more to see how inflation goes before making a decision as to whether he needs to raise rates again. So that bit of information is absolutely critical. Had inflation not turned around September, we probably would have anticipated a rate increase today. And hopefully that's what he would have done. Because again, inflation is not at 2% or in a 3.5% range. And that's still far from where it needs to be.
AL: So maybe let's break down where we're at in terms of inflation. So, we've been having these conversations, you've been on the podcast quite a few times over the past, I guess 18 months or so, 10 increases over that time. Where are we after all of that action from the Bank of Canada on inflation?
JFP: Well, I mean, the good news is inflation is a lot lower now than it was a year ago. So we look at headline inflation, so 3.8%. You know, it was over 8% at some points last year. So that's good progress. All of that is due to oil prices. So, it's not really a reflection of the fact the bank has policies are leading to a decline in inflation. That's not it. When we look at underlying measures of inflation, so when we take out food and energy and we take out some of the more volatile elements of inflation, you get a sense of what trend inflation is, kind of underlying dynamics of inflation, that's been stuck in 3.5 to 4% range, depending which measures you're looking at for almost a year now. So, there's much less evidence that inflation dynamics have actually shifted in a meaningful way towards 2%. When you look at these, again, underlying measures of inflation. So, there's been progress, but not nearly enough for anybody to be comfortable about the inflation situation now and for anybody to be comfortable enough to say the Bank of Canada's done, and, you know, they're going to be cutting at the next meeting.
AL: Another factor when it comes to inflation that the Bank of Canada mentioned in their statement today is the potential impact of the Israel-Hamas war. I wanted to get your thoughts on how much of a factor is that in this decision or in future decisions.
JFP: I don't think it's a factor in this decision, I mean it creates a little bit of uncertainty. But, if you if you game out the Israel-Hamas war, you know, the concern apart from obviously the human cost, which is horrible, the concern is that this is a conflict that broadens out into other players in the region, including Iran. And if you get into that world, then you're talking more about a world where oil prices probably rise a very significantly. At a time when we're trying to control inflation, you get a very significant oil price shock that adds inflationary pressure, almost certainly would put upward pressure on policy rates. Right. So, the risk is if the situation gets further out of hand, that you end up with higher rates as a result as opposed to lower rates.
AL: Do those global issues also have a potential impact on the other thing we're watching for, which is recession, the impact of all that uncertainty and other factors on the economy?
JFP: Well, certainly when you think about the big risks, the risks are to the downside. So, there's this war. You can think of what's happened in U.S. bond markets the last several weeks where bond yields have risen a lot. And the governor talked about that today, which is effectively an increase in the cost of financing. So, a bit of an additional monetary tightening that poses a downside risk to the outlook for sure. So those are two big things that do suggest that the risks are probably a little bit tilted to the downside relative to where they were a few weeks ago or a couple of months ago. That being said, incoming economic data in Canada, you know, while they point to a slowdown, they're not uniformly pointing to a slowdown. We saw the labour market, which is still pretty robust, job vacancies still high, firms are still hiring by quite significant amounts. Wages are rising even more rapidly. So, it's not like everything is pointing to, a very worrisome economic outlook. It's pointing to a slowdown and these kind of external developments – these things that really have nothing to do with monetary policy in Canada, they're not home grown by any stretch of the imagination – do pose some risks to the outlook, which are pretty clear to the downside.
AL: It's a lot of factors to consider, a lot of moving parts, a lot of things that can change. So if you are, say, renewing your mortgage in the next few months, looking at all of this, what should you make of all that?
JFP: it’s obviously not a very easy decision for people right now. You know, our sense is that rates are going to go down as the year progresses. Sorry, as the next 12 months progress not this year. So, if you've got an ability to wait a little bit, then I would wait a little bit because you're going to get better clarity on whether or not the Bank of Canada will have increased interest rates. We don't think that's going to be the case, but you never know. So, it's very much an environment where I think homeowners and mortgage owners have to be aware of the fact that there is a risk that rates go up further. So that might mean, you know, if you take a variable mortgage now that you might pay a little bit more in the next few months, if that's what you do. Maybe you want to take a fixed rate mortgage for a year or two and kind of ride the uncertainty of the next year or two and then lock into something and a little bit later on or go into variable rate mortgage at a little bit later stage. But it's really important that people keep in mind that, whatever mortgage product they choose, that there is a risk in the short run that rates go up a little bit higher and to be prepared for that.
AL: So I wanted to go back to rate cuts, which will eventually happen. I guess the question is when. I think last time you had said it would be possible next year, late spring, early summer, is that still what you're seeing based on what we see right now?
JFP: That's what we see. Again, there are plenty of signs of the economy slowing. There are many signs of inflation slowing. But we're confident, at least or we're crossing our fingers, that that happens, as I'm sure is the governor of the Bank of Canada. And if we do have compelling signs that the economy slowed by next spring, then inflation is in a much better dynamic, then yeah, we're reasonably confident the Bank of Canada will start cutting then. And the question obviously, one is of timing, so when? So, late spring, early summer a little bit later on. And then the pace, how much cutting do they do and how fast does that go. So, we're of the view still a cut middle of next year, again, late spring, early summer and then maybe about 100 basis points of cuts between then and the end of 2024. So, a reasonable, gradual pace of cutting in relation to the speed at which rates have gone up over the last 18 months.
AL: So if you had to boil down this latest decision to three key takeaways for Canadians, what would they be?
JFP: Well, I think the first is for people to not expect rates to go down anytime soon and for people to plan or at least be aware that there's a good possibility rates go up further. It's very clear in the governor’s communications he wants people to understand that. The second is it's also very clear that inflation is nowhere near where it needs to be. It's way too high still. And inflation is a tax on people. It does hurt household finances. So that is not something that's going away anytime soon either. It will eventually. But the risks, again, as indicated by the governor of the Bank of Canada, is that inflation is stubbornly high and may be higher than we want for the next little while. And the third is we know now and it's clear that interest rates are impacting the economy. And that impact is going to grow over time. So, the pain that is being felt by Canadians now to some extent will grow. And that is not something that the governor of the Bank of Canada is going to fear. That's something the governor of the Bank of Canada is encouraging. He wants to happen. He wants to see that because that slowdown in economic activity and some of the pain that results from that is what's needed to bring inflation down over time.
AL: I wanted to ask one last question. So, we've been having these conversations for quite a while since the first Bank of Canada increase of this cycle anyway in March 2022. And what you have said again and again is that it takes about 18 to 24 months for those actions to work its way through the economy. We're at the 18 month mark now. So looking back at the past 18 months, what Bank of Canada has done, is it working? Was it the right moves? Is it doing what it had intended to do?
JFP: It seems pretty clear to us now that the Bank of Canada messed up in terms of when they actually started raising interest rates. So, March 2022 was probably a little bit too late. And certainly that's what we thought going into the end of 2021 and early 2022. So you can question whether or not that was the right thing. We have a view on that. And then you can question whether or not once they did start to go, if they went fast enough. And our sense is they didn't go fast enough. So, there's an element of, had they moved earlier, had they moved faster, we may not be at 5% now. We would have seen some signs of weakness a little bit earlier on and maybe we'd be on a different path for inflation than the path that we're currently on. It's easy to it's easy to make that assessment, it’s easy to make that criticism. But of course, the governor makes decisions in a very dynamic world. So, you had through that time fiscal policymakers in Canada providing relief to individuals which complicated the task of monetary policy tremendously. You've had record population growth, which of course, you couldn't possibly have anticipated. That's got ambiguous impacts on the economy, but made his life more difficult. So, there were things that have gone on as interest rates have increased that have really impacted the way interest rates impact the economy. And that's made his life much, much more difficult than probably was the case with previous central bankers dealing with inflation issues in the past.
AL: JF, thanks so much for joining us.
JFP: Thanks for having me.
AL: I've been speaking with Jean-François Perrault, the Chief Economist at Scotiabank.
