TD Bank economists don’t envy the job facing the Bank of Canada, calling it “one of the toughest … within the financial industry this year” as the central bank faces pressure to correctly time the first interest rate cut since its historic hiking cycle peaked in July.
A new analysis from TD suggests that the Bank of Canada might have to start cutting rates before inflation comes down to its two per cent target to prevent the economy from running aground.
“The Bank of Canada won’t be able to wait until all the stars align before starting the process of normalizing interest rates,” said Beata Caranci senior vice-president and chief economist, and James Orlando, senior economist, at TD Economics, in an analysis released on Jan. 10.
Part of that celestial misalignment involves shelter inflation, which is “still running hot.”
Shelter costs in Canada rose 5.9 per cent year over year in November, according to the most recent inflation report, while mortgage costs were up 30 per cent year over year. On the other side of the ledger, the number of products registering inflation of less than three per cent continued to grow and “the share in outright deflation territory is also on the high side relative to the pre-pandemic period,” the TD economists said.
Among the challenges for central bank governor Tiff Macklem and his deputies will be to convince consumers that the rising cost of housing and financing mortgage debt is not representative of the whole inflation picture and to corral household inflation expectations, which are overly influenced by shelter costs in relation to their actual weight in the consumer price index basket of goods, Caranci and Orlando said.
“The BoC will be forced down one of two paths: Fight shelter-fuelled inflation until the bitter end or recognize that growth/inflation dynamics will warrant rate cuts sooner rather than later,” they said.
Caranci and Orlando believe there are three reasons the central bank will start cutting with inflation “still at the upper end of the central bank’s targeted range” of three per cent, while shelter inflation remains elevated.
Reason 1: The real interest rate, which reflects the true cost of borrowing, is already in “restrictive territory,” meaning it is reducing the amount of money and credit that banks are lending and increasing economic risks.
Reason 2: “Financial risks could also become magnified,” Caranci and Orlando warned in their note.
They argued that the Bank of Canada left interest rates too low for too long in the wake of the pandemic. That led to more consumers taking out variable-rate mortgages and an increase in mortgage debt.
“Now the central bank must keep those risks top of mind at the other end of the spectrum in leaving rates too high for too long,” they said.
Reason 3: Despite the fact that the central bank’s favourite inflation measures — at 3.5 and 3.4 per cent year over year — remain outside the target range, the number of items driving inflation in Canada has continued to shrink over the past 18 months.
That shows that consumer demand has continued to slow.
“This three-pronged thought framework sounds simple enough as a basic overview, but not so if you’re a central banker, which will be one of the toughest jobs within the financial industry this year,” they said.
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Higher rents and food prices boosted overall United States inflation in December, a sign that the U.S. Federal Reserve’s drive to slow inflation to its two per cent target may be a bumpy one.
Thursday’s report from the Labor Department showed that overall prices rose 0.3 per cent from November and 3.4 per cent from 12 months earlier. Those gains exceeded the previous 0.1 per cent monthly rise and the 3.1 per cent annual inflation in November.
Excluding volatile food and energy costs, so-called core prices rose just 0.3 per cent month over month, unchanged from November’s increase. Core prices were up 3.9 per cent from a year earlier, down a tick from November’s four per cent year-over year gain. Economists pay particular attention to core prices because, by excluding costs that typically jump around from month to month, they are seen as a better guide to the likely path of inflation.
Overall inflation has cooled more or less steadily since hitting a four-decade high of 9.1 per cent in mid-2022. Still, the persistence of still-elevated inflation helps explain why, despite steady economic growth, low unemployment and healthy hiring, polls show many Americans are dissatisfied with the economy — a likely key issue in the 2024 elections.
The Federal Reserve, which began aggressively raising interest rates in March 2022 to try to slow the pace of price increases, wants to reduce year-over-year inflation to its two per cent target level.
The Associated Press
- The Canada Energy Regulator is slated to hear arguments from Trans Mountain Corp. on its request for a pipeline variance. The company says without the variance, the expansion of the pipeline could face a two-year delay.
- The Parliamentary Budget Officer releases a new report titled Income dynamics of new immigrants to Canada
- Today’s data: United States producer price index
- Earnings: Corus Entertainment Inc., Bank of America Corp., Citigroup Inc., Wells Fargo & Co. Delta Air Lines Inc., JPMorgan Chase & Co., BlackRock Inc.
Get all of today’s top breaking stories as they happen with the Financial Post’s live news blog, highlighting the business headlines you need to know at a glance.
The change of the calendar signalled an increase to statutory payroll deductions, which means some of us will be getting slightly smaller paycheques than we’re used to. Debt counsellor and personal finance expert Sandra Fry shares practical tips to help you cope with the reduction. Read her column here.
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Today’s Posthaste was written by Gigi Suhanic, with additional reporting from The Canadian Press and Bloomberg.
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