Bank of Canada is still way behind the curve: David Rosenberg

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There was an expanding narrative of how the Bank of Canada was going to unleash a fresh wave of housing inflation when it began to cut rates four months ago. The exact opposite has happened.

The September data for the dominant Greater Toronto Area showed a huge 9.8 per cent surge in the number of new listings hitting the market (supply), which tripled the 3.3 per cent increase in resale activity (demand). This gap caused a 0.5 per cent month-over-month slide in average home prices (to a still-inflated $1.08 million) and is down five per cent now on a year-over-year basis.

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And look at what is happening out on the once-hot West Coast, where new listing volumes in Vancouver skyrocketed 50 per cent month over month in September at the same time that sales slipped 2.7 per cent. That combination brought the average home price down 1.4 per cent month over month and by 1.8 per cent on a year-over-year basis (and still a whole lot of air under this thing as average home prices still sit at a bubbly $1.18 million).

This is all very important to the Bank of Canada, since headline inflation is already down to two per cent year over year despite shelter inflation still running hot at 5.3 per cent (though off the boil). Imagine what will happen once the housing numbers in the consumer price index begin to match what is happening in the residential real estate market in real time, because the ex-shelter inflation rate is running at 0.5 per cent year over year (from 3.2 per cent a year ago).

If you take into account the “convergence” theme and then consider that the historical norm is for the policy rate to command a 50- to 100-basis-point premium over the inflation rate, the prospect is that we close this easing cycle in Canada closer to one per cent or 1.5 per cent (from 4.25 per cent now).

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Keep in mind that the real or inflation-adjusted Bank of Canada rate today sits at 2.55 per cent, the highest it has been since August 2007. Indeed, the policy rate is 75 basis points lower than it was a year ago, but inflation has fallen much harder (120 basis points for core inflation, 180 basis points for CPIX inflation (which excludes a set of components from the CPI basket) and 200 basis points for headline inflation).

Even as the Bank of Canada has cut nominal rates, the slide in inflation means that, in real terms, policy has been tightened rather unnecessarily by more than 100 basis points over the past year. It’s rather bizarre that the central bank would allow itself to fall this far behind the curve given that year-over-year real gross domestic product growth has decelerated sharply below-trend to 0.9 per cent from 1.3 per cent, while the unemployment rate hooked up to a three-year high of 6.6 per cent from 5.5 per cent a year back.

All this means is that the front end of the Canadian bond curve (with the two-year yield at around 3.1 per cent) has at least 100 basis points of downside yield potential and 50 basis points for the five-year (now at 2.9 per cent). The 10-year Government of Canada and long bond are pretty well already priced for the environment we are depicting.

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The Canadian dollar, at 74 cents U.S., has been held together by the positive action in the commodity markets of late, but at some point, the Chinese stimulus effect will fade, and so will the war in the Middle East.

The prospect that the Bank of Canada cuts way more than the United States Federal Reserve and given how critical interest rate differentials (not to mention economic growth divergences) are in any determination of currency directions makes it rather difficult to be bullish on the Canadian dollar at current levels.

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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