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Canadian inflation fell to 2.5% in July, its lowest since March 2021. Robert Both, Senior Macro Strategist with TD Securities, discusses what that means for interest rates ahead of the Bank of Canada’s upcoming meeting in September.
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Canadian headline inflation cooling to 2.5% in July. This is the lowest level in more than three years. Does that open the door for another Bank of Canada rate cut as early as September? Joining us now to discuss is Robert Both, Senior Macro Strategist with TD Securities. Great to have you with us, Robert.
Thank you, Greg. It's great to be back on the program.
2.5%, getting closer to 2%. The market seems to like this report. Let's go through the inflation report first. Were there any surprises in there for you? Because we have been tracking lower.
Yeah. So, as you mentioned off the top, headline CPI was in line with where we thought it was going to be. It was in line with where the market thought it was going to be. But I think the details were a little bit softer than we'd expected. What I'm referring to is that the Bank of Canada's preferred measures of core inflation, those printed at about 2.55% on average, one of them sitting at 2.4%, one of them is sitting at 2.7%. But that was a tenth lower than where we in the market saw them.
And that means that those three-month rates of core inflation that the Bank of Canada likes to look at as a gauge of where inflation is trending, that looks a little bit softer than we'd anticipated. So, overall, this is very positive news. If you look at what drove that improvement from last month, it is a lot of those cyclical components that you would expect to come under a little more pressure for higher rates.
So discretionary components, like motor vehicles, hotels, airfares, large household appliances-- those are all the components that are dragging inflation lower on a year-over-year basis. And that is likely to give the Bank of Canada a little more confidence that we're still on track to get to that 2% target.
Something you and I have talked about in terms of that headline inflation number-- when you strip out the shelter costs, I think we're down to 1.2% inflation if you strip out shelter. And that was one of those things where the Bank of Canada has been asked repeatedly about, does that matter to them?
Right. Ex-shelter is running at 1.2%. It was about 1.3% last month, so not a huge change there. But the shelter costs are also starting to see a little more progress as well. If you look at that headline index, it improved more than the ex-shelter.
So we are seeing that evidence of deceleration in things like rents. We're certainly seeing it in mortgage interest costs. And as that gap between shelter and everything else grows smaller, it's going to be a lot easier to get all the way from 2.5% back down to 2.0%.
So as we talk about those things, obviously, the Bank of Canada taking a look in this report-- they've got an announcement, what, two weeks from now, three weeks now? It's early September, anyway. What does it actually mean for them? I feel after these two cuts that we got this summer, there was a bit of hesitation in the market-- will they or won't they in September? Does this change the story?
So I think what the bank is going to be looking at in this report is they are going to be looking at that early signs of progress on shelter prices. They're going to be looking at that more modest performance across the bank's preferred measures of core inflation. And what I think those two stories are going to tell them is that some of these concerns around inflation proving a little more persistent-- things like shelter and core services help keeping inflation elevated into next year-- some of those concerns might be fading away a little bit. So the market didn't necessarily need to see that much evidence.
We were already priced for a 25 basis point in September heading into this report. But I think this report will give the bank a little more conviction that that path is still intact. And we do believe this report is going to give the bank a green light to ease rates again in September.
So if they do ease again in September, we'll have had three cuts under our belt. What does the rest of the year look like for the Bank of Canada?
So we think we're going to get one more cut in September and then one more cut in October. So that would be four in a row for 100 basis points of easing. But we do still think there is going to be a pause this year. So we're looking for that pause to come in December.
Our previous forecasts had it in September. But we think, even with the progress we've seen in today's CPI report, the case for another rate cut isn't necessarily as large of a slam dunk as the market might be implying. You can look at things like wage growth still being a little elevated. There is certainly parts of the services basket that are still seeing those pressures.
And inflation expectations have been somewhat mixed over the last few quarters as well. So the Bank of Canada does seem to be putting a lot more weight on excess capacity. What we're seeing in labor markets, that should make it a little bit easier to look through some of these more persistent underlying price pressures.
But, overall, the 2% target is coming into view. We're marking new ground today. And we do think that is going to support rate cuts in September and October.
"Anxiety" might be too strong a word, but do you think there's any lingering concerns for the Bank of Canada? I think of the conversations we've had earlier this year leading into those two rate cuts-- you're thinking another one in September-- but they didn't want to get this wrong. When inflation first showed up, the central bank says "transitory," don't worry, we can work our way through this.
They relate to trace it and try to bring it back down. Do you think their anxieties are easing that they might be making the wrong call?
I think their anxieties are shifting, perhaps.
It was always something to be worried about-- just put it over here, right?
So when we saw those first two rate cuts from 5% to 4.75%, 4.75% to 4.5%, it still wasn't a foregone conclusion that the bank was going to continue easing all the way until we got to neutral. We've been through periods this spring where you have seen those inflation pressures materialize quite sharply.
Core inflation saw a series of strong month-over-month advances from March all the way into May. And wage growth has remained strong. So I think even as that first Bank of Canada cut materialized, there was a little uncertainty about, is there really no risk that they're forced to hike again? I think any discussion about inflation re-accelerating from here is certainly taking on less importance in the bank's deliberations going forward.
And I think those discussions are more likely to shift into 2025 to whether or not we're actually going to be able to stop at neutral or whether or not the bank is going to, perhaps, look at going through neutral if inflation does appear on track to undershoot the 2% target, which is not our base case.
So longer term, obviously, you're talking about getting back to neutral rates, where you're no longer trying to tamp down the economy to tame inflation. You're not trying to reinvigorate it as well to catch up to slow growth. Where does the bank think neutral is? Where do we think neutral is?
So the bank thinks neutral is at 2.75%. So as you look out into 2025 and 2026 right now, markets are placing some risk that we end up going below neutral. If you look at where the end of the cutting cycle is priced, it's closer to about 2.5%
We think neutral is going to be 3%. The bank upgraded it from 2.5% to 2.75% in April last year. We do think they will upgrade it again in April of next year. But neutral is unobservable. So I guess we will know we're there once we're there.
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Canadian headline inflation cooling to 2.5% in July. This is the lowest level in more than three years. Does that open the door for another Bank of Canada rate cut as early as September? Joining us now to discuss is Robert Both, Senior Macro Strategist with TD Securities. Great to have you with us, Robert.
Thank you, Greg. It's great to be back on the program.
2.5%, getting closer to 2%. The market seems to like this report. Let's go through the inflation report first. Were there any surprises in there for you? Because we have been tracking lower.
Yeah. So, as you mentioned off the top, headline CPI was in line with where we thought it was going to be. It was in line with where the market thought it was going to be. But I think the details were a little bit softer than we'd expected. What I'm referring to is that the Bank of Canada's preferred measures of core inflation, those printed at about 2.55% on average, one of them sitting at 2.4%, one of them is sitting at 2.7%. But that was a tenth lower than where we in the market saw them.
And that means that those three-month rates of core inflation that the Bank of Canada likes to look at as a gauge of where inflation is trending, that looks a little bit softer than we'd anticipated. So, overall, this is very positive news. If you look at what drove that improvement from last month, it is a lot of those cyclical components that you would expect to come under a little more pressure for higher rates.
So discretionary components, like motor vehicles, hotels, airfares, large household appliances-- those are all the components that are dragging inflation lower on a year-over-year basis. And that is likely to give the Bank of Canada a little more confidence that we're still on track to get to that 2% target.
Something you and I have talked about in terms of that headline inflation number-- when you strip out the shelter costs, I think we're down to 1.2% inflation if you strip out shelter. And that was one of those things where the Bank of Canada has been asked repeatedly about, does that matter to them?
Right. Ex-shelter is running at 1.2%. It was about 1.3% last month, so not a huge change there. But the shelter costs are also starting to see a little more progress as well. If you look at that headline index, it improved more than the ex-shelter.
So we are seeing that evidence of deceleration in things like rents. We're certainly seeing it in mortgage interest costs. And as that gap between shelter and everything else grows smaller, it's going to be a lot easier to get all the way from 2.5% back down to 2.0%.
So as we talk about those things, obviously, the Bank of Canada taking a look in this report-- they've got an announcement, what, two weeks from now, three weeks now? It's early September, anyway. What does it actually mean for them? I feel after these two cuts that we got this summer, there was a bit of hesitation in the market-- will they or won't they in September? Does this change the story?
So I think what the bank is going to be looking at in this report is they are going to be looking at that early signs of progress on shelter prices. They're going to be looking at that more modest performance across the bank's preferred measures of core inflation. And what I think those two stories are going to tell them is that some of these concerns around inflation proving a little more persistent-- things like shelter and core services help keeping inflation elevated into next year-- some of those concerns might be fading away a little bit. So the market didn't necessarily need to see that much evidence.
We were already priced for a 25 basis point in September heading into this report. But I think this report will give the bank a little more conviction that that path is still intact. And we do believe this report is going to give the bank a green light to ease rates again in September.
So if they do ease again in September, we'll have had three cuts under our belt. What does the rest of the year look like for the Bank of Canada?
So we think we're going to get one more cut in September and then one more cut in October. So that would be four in a row for 100 basis points of easing. But we do still think there is going to be a pause this year. So we're looking for that pause to come in December.
Our previous forecasts had it in September. But we think, even with the progress we've seen in today's CPI report, the case for another rate cut isn't necessarily as large of a slam dunk as the market might be implying. You can look at things like wage growth still being a little elevated. There is certainly parts of the services basket that are still seeing those pressures.
And inflation expectations have been somewhat mixed over the last few quarters as well. So the Bank of Canada does seem to be putting a lot more weight on excess capacity. What we're seeing in labor markets, that should make it a little bit easier to look through some of these more persistent underlying price pressures.
But, overall, the 2% target is coming into view. We're marking new ground today. And we do think that is going to support rate cuts in September and October.
"Anxiety" might be too strong a word, but do you think there's any lingering concerns for the Bank of Canada? I think of the conversations we've had earlier this year leading into those two rate cuts-- you're thinking another one in September-- but they didn't want to get this wrong. When inflation first showed up, the central bank says "transitory," don't worry, we can work our way through this.
They relate to trace it and try to bring it back down. Do you think their anxieties are easing that they might be making the wrong call?
I think their anxieties are shifting, perhaps.
It was always something to be worried about-- just put it over here, right?
So when we saw those first two rate cuts from 5% to 4.75%, 4.75% to 4.5%, it still wasn't a foregone conclusion that the bank was going to continue easing all the way until we got to neutral. We've been through periods this spring where you have seen those inflation pressures materialize quite sharply.
Core inflation saw a series of strong month-over-month advances from March all the way into May. And wage growth has remained strong. So I think even as that first Bank of Canada cut materialized, there was a little uncertainty about, is there really no risk that they're forced to hike again? I think any discussion about inflation re-accelerating from here is certainly taking on less importance in the bank's deliberations going forward.
And I think those discussions are more likely to shift into 2025 to whether or not we're actually going to be able to stop at neutral or whether or not the bank is going to, perhaps, look at going through neutral if inflation does appear on track to undershoot the 2% target, which is not our base case.
So longer term, obviously, you're talking about getting back to neutral rates, where you're no longer trying to tamp down the economy to tame inflation. You're not trying to reinvigorate it as well to catch up to slow growth. Where does the bank think neutral is? Where do we think neutral is?
So the bank thinks neutral is at 2.75%. So as you look out into 2025 and 2026 right now, markets are placing some risk that we end up going below neutral. If you look at where the end of the cutting cycle is priced, it's closer to about 2.5%
We think neutral is going to be 3%. The bank upgraded it from 2.5% to 2.75% in April last year. We do think they will upgrade it again in April of next year. But neutral is unobservable. So I guess we will know we're there once we're there.
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