Bank of Canada still way behind the curve: David Rosenberg

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If the Bank of Canada had the same dual mandate as the United States Federal Reserve, it would consider stepping up the pace of its rate-cutting plan, because looking at the situation with the benefit of hindsight, it went way too far in 2022-2023 with its aggressive hikes and overreacted to one month of eight per cent inflation.

The latest data for July showed consumer prices rising 0.3 per cent on a seasonally adjusted basis, mostly on the back of gasoline prices, but the details were rather encouraging and the broad trends are running in the right direction. This all but locks in more rate cuts ahead, but it must be understood that all the central bank is doing now is removing excessive policy restraint. We are at least 175 basis points away from being offered any real net stimulus for what can be characterized as, at best, a moribund economy.

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Inflation cooling

The year-on-year consumer price index (CPI) slowed to 2.5 per cent in July from 2.7 per cent in June, and we saw really good news in some of the important metrics the Bank of Canada monitors. The CPI-trim inflation rate cooled off to 2.7 per cent year over year from a 2.8 per cent reading in June (revised down from 2.9 per cent) — a tad below the 2.8 per cent consensus forecast as well — and the CPI-median metric decelerated nicely to 2.4 per cent from 2.6 per cent (consensus was 2.5 per cent).

The “common component” of core inflation eased for the 11th month in a row to 2.2 per cent, from 2.3 per cent in June and 4.7 per cent a year ago — you have to go back to April 2021 to see the last time this measure was running at such a low pace. It’s now back to where it was pre-COVID-19, in January 2020, when the policy rate was 1.75 per cent, not 4.5 per cent, giving us a sense of the long road ahead for the Bank of Canada’s rate-cutting path.

The core ex-food and energy component came in light again, at 0.2 per cent sequentially for the second month in a row and has been in line with this sort of number or lower in seven of the past eight months. The annual trend on this score dipped from 2.9 per cent in June to 2.7 per cent in July and 3.4 per cent a year ago.

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The all-important CPIX price metric, which excludes the eight most volatile components of the CPI, eased to 1.7 per cent from 1.9 per cent in June and 3.2 per cent a year earlier, which is below the mid-point of the Bank of Canada’s target band for inflation. On a month-to-month, seasonally adjusted basis, this key price statistic came in very light, at 0.1 per cent, for the second month running (and has posted a microscopic number such as this in seven of the past eight months as well). The six-month trend is running close to a 1.6 per cent annualized rate, having been sliced in half over the past year.

The bee in the bonnet of inflation phobes all along has been the shelter component, but that softened to just a 0.2 per cent increase last month, the faintest pulse in nearly a year and a half. So, the lags from the prior Bank of Canada rate hikes, which have softened the residential real estate market, are finally showing through in the various housing components. And the unwillingness of Canadians to deploy savings toward current consumption was revealed by the 0.2 per cent deflation in recreational service prices after a 0.7 per cent slide in June (now running completely flat on a year-over-year basis).

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Strip out the shelter component, which is still running at 5.7 per cent year over year (though clearly off the boil), and the other 70 per cent of the pricing pie has inflation at a mere 1.2 per cent year-over-year pace from 2.6 per cent a year ago.

Labour market faltering

Meanwhile, cracks are clearly emerging in the labour market. Canadian employment fell by 2,800 in July, which came as a shock to the Bay Street economists’ estimate of a 25,000 rebound — and this came off the 1,400 dip in June. Not even a 40,800 spike in public-sector employment could give this pig of a report any lipstick — the near 42,000 plunge in private-sector employment represented the worst showing in more than two years.

The only reason the unemployment rate stayed the same, at 6.4 per cent (tied for the highest level since January 2022 and below the pre-COVID-19 level of 5.5 per cent) was because the labour force participation rate sharply contracted to a three-year low of 65 per cent, from 65.3 per cent previously (an ominous signal given the boom in immigration). Had it not been for the 0.3 percentage point drop in the participation rate, the unemployment rate would have come in at just below seven per cent last month.

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One of the measures of labour market slack that the Bank of Canada likes to focus on is the employment-to-population ratio, which fell for the third month in a row to 60.9 per cent from 61.1 per cent in June, which is the lowest rate since August 2021. This ratio is down 1.1 percentage points from last year, marking the longest period of continuous monthly drops since 2009.

The broadest measure of unemployment, the R8 metric, which includes all forms of idle labour, jumped to 8.6 per cent from 7.6 per cent a year ago. In July 2019, when the Canadian economy was in a better balance, this metric was sitting at 7.7 per cent — and the policy rate was 1.75 per cent. Hence, our steadfast bullish assessment of the Government of Canada bond market (especially the front end and mid-part of the curve).

More interest rate cuts coming

The Bank of Canada acted too late, but is now on its game, and more rate cuts are surely coming our way, all the way down on the policy rate to at least the mid-point of “neutral” at 2.75 per cent (currently 4.5 per cent). I say “at least” because the central bank will not be able to stop at neutral given the recessionary pressures that are building and inflation pressures that are visibly fading out of view.

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Tiff Macklem and Co. would be well advised to bring the policy rate into alignment with underlying inflation, which would mean rolling back most — if not all — of that unnecessary John Crow-like tightening cycle in 2022 and 2023 that took the policy rate up to the five per cent peak from 1.75 per cent pre-pandemic.

The labour market and inflation have done more than just “normalize,” and yet, even with two rate cuts under its belt, the Bank of Canada has a very long way to go to “normalize” monetary policy.

David Rosenberg is founder and president of independent research firm Rosenberg Research & Associates Inc. To receive more of David Rosenberg’s insights and analysis, you can sign up for a complimentary, one-month trial on the Rosenberg Research website.

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