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The Bank of Canada held its key interest rate steady at 5%, highlighting that higher interest rates are clearly restraining spending. Anthony Okolie speaks with Francis Fong, Senior Economist at TD, about the latest decision and the outlook for rates going forward.
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[AUDIO LOGO]
* As expected, the Bank of Canada held its key rate steady at 5%. Joining me now with more is Francis Fong, Senior Economist at TD. Francis, did anything stand out for you today?
* Yeah. Thanks for having me, Anthony. So as you already mentioned, it was widely expected that they would hold the interest rate today-- so not a lot of surprises. I think the key focus in the communique was a lot on the growth numbers, not just here in Canada, but also what's happening in the US, what's happening globally.
* As a small, open economy, we are very vulnerable to a lot of these international factors. So where growth heads globally, we're going to follow. So the focus on the EU where growth is slowing quite a lot and inflation has slowed quite a lot was a big focus. And then also, the US numbers, which are stronger than they are here in Canada, but still, a lot of evidence that things are slowing down here. So that's got to be key for the Bank of Canada.
* And as you said, the Bank of Canada said that economic growth has stalled. What are your expectations for the economy going forward?
* Yeah. So we narrowly avoided a technical recession. We had a small negative print in the second quarter. That was upwardly revised. But then we got a negative print for the third quarter-- so just sliding by this two negative prints for a technical recession. But the underlying factors, I think, were all kind of pointing to the downside-- consistent with what you would expect in an interest rate environment as high as we're in today.
* So consumer spending was quite weak. The export sector was surprisingly weak-- again, kind of contributing to this kind of negative international sentiment going on today. But going forward, we don't anticipate growth to be much, much stronger than where it is today-- largely flat through the beginning of next year.
* And then even the recovery is expected to be slow. Because keep in mind, the impact of interest rate hikes, they take time. It takes 18 to 24 months for each interest rate hike to fully filter through to the economy. So you can expect more impacts on consumer spending, more impacts on debt service, and that's going to keep the economy from really kind of taking off down the line.
* So given that economic backdrop, do you think the Bank of Canada is done with rate hikes? And when do you expect them to start cutting rates?
* So absolutely. I think given where the growth trajectory is across all advanced economies, I think most are anticipating that, including ourselves, central banks, like the Federal Reserve, Bank of Canada, et cetera are done with rate hikes. So then the real question is, when do we hit that inflection point where rate cuts are appropriate?
* Because interest rates of this level really aren't consistent with the kind of underlying potential growth of our economy. So they're biting. So at what point do we start to see cuts? And our anticipation is around the first quarter of the year is when the Bank of Canada starts cutting. That being said, I think the risks are still to the upside.
* Some of the data that we are getting in still is pointing to underlying inflationary pressure, namely the strength in the labor market, we got a decent sized job print the other day, and wage growth, which is still running relatively hot at around 5% year over year. So those wage gains kind of put a little bit of a floor underneath the degree to which the Bank of Canada can start discussing rate cuts. But that being said, first quarter is our anticipation.
* OK, so I want to talk about how the markets are right now pricing in potential moves. We have seen some movement in the money markets, in the Bank of Canada's overnight rate. How do you interpret that? What are they saying?
* And I think it's actually consistent with what I was just talking about. Markets are still really on the fence in terms of when that first cut happens. So the March meeting, you're starting to see sentiment turn into just on the cusp of a rate cut. They're putting the chances at about 38%, which is not high.
* But that's the first kind of opportunity, I think, that markets are pricing in for a rate cut. But that's really going to be dependent on what the growth trajectory does look like. If the fourth quarter comes in significantly weak, as folks anticipate, and if the emerging evidence is that the first quarter is going to follow suit, then that gives them room to make that first cut.
* But I think markets are kind of hedging their bets and thinking the risks are still to the upside. And I think if you look at the US, where growth is kind of a little more resilient, consumers are a little more resilient, you take that as evidence that those upside risks are still at least present.
* OK. Now, the next Bank of Canada rate announcement is not till January. What are some of the indicators you'll be watching closely as the Bank of Canada considers its next move?
* Yeah. So it's really going to be, where do those underlying inflationary pressures come from? We've seen the volatile stuff sort of come in-- like oil prices, gasoline, all that kind of stuff. But the underlying price growth, which is going to come from wage gains, services inflation, services spending-- a lot of things now around the consumer.
* Most notably, I would note that we're still looking to the degree to which higher interest rate hikes start to feed into those consumer spending numbers. So as more people are renewing their mortgages into those higher interest rates, what kind of impact does that have? We're really testing the bounds of how much excess liquidity was built into the system after COVID, which we saw a huge surge because of government stimulus.
* But we've been slowly winding that down. How much is left? And what impact are those higher rates going to have? That's kind of the big question right now.
* OK. The final question is, where do you see the Canadian dollar going over the next little while?
* Yeah. It's a great question. Right now, we're still in a very weak space simply because the interest rate differential relative to the US is still quite high. And as I mentioned earlier, the data that we're seeing in the US is still a little bit stronger than it is in Canada. So while we're anticipating a very similar pathway for the Federal Reserve, until that interest rate differential starts to come in, we're likely not to see the Canadian dollar recover too, too much. So it'll be a slow, long recovery back to some normalcy through at the end of our forecast horizon, likely out to 2025 by the time we see a normal level for the CAD.
* Francis, thanks very much for joining us.
* It's been a pleasure, Anthony.
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* As expected, the Bank of Canada held its key rate steady at 5%. Joining me now with more is Francis Fong, Senior Economist at TD. Francis, did anything stand out for you today?
* Yeah. Thanks for having me, Anthony. So as you already mentioned, it was widely expected that they would hold the interest rate today-- so not a lot of surprises. I think the key focus in the communique was a lot on the growth numbers, not just here in Canada, but also what's happening in the US, what's happening globally.
* As a small, open economy, we are very vulnerable to a lot of these international factors. So where growth heads globally, we're going to follow. So the focus on the EU where growth is slowing quite a lot and inflation has slowed quite a lot was a big focus. And then also, the US numbers, which are stronger than they are here in Canada, but still, a lot of evidence that things are slowing down here. So that's got to be key for the Bank of Canada.
* And as you said, the Bank of Canada said that economic growth has stalled. What are your expectations for the economy going forward?
* Yeah. So we narrowly avoided a technical recession. We had a small negative print in the second quarter. That was upwardly revised. But then we got a negative print for the third quarter-- so just sliding by this two negative prints for a technical recession. But the underlying factors, I think, were all kind of pointing to the downside-- consistent with what you would expect in an interest rate environment as high as we're in today.
* So consumer spending was quite weak. The export sector was surprisingly weak-- again, kind of contributing to this kind of negative international sentiment going on today. But going forward, we don't anticipate growth to be much, much stronger than where it is today-- largely flat through the beginning of next year.
* And then even the recovery is expected to be slow. Because keep in mind, the impact of interest rate hikes, they take time. It takes 18 to 24 months for each interest rate hike to fully filter through to the economy. So you can expect more impacts on consumer spending, more impacts on debt service, and that's going to keep the economy from really kind of taking off down the line.
* So given that economic backdrop, do you think the Bank of Canada is done with rate hikes? And when do you expect them to start cutting rates?
* So absolutely. I think given where the growth trajectory is across all advanced economies, I think most are anticipating that, including ourselves, central banks, like the Federal Reserve, Bank of Canada, et cetera are done with rate hikes. So then the real question is, when do we hit that inflection point where rate cuts are appropriate?
* Because interest rates of this level really aren't consistent with the kind of underlying potential growth of our economy. So they're biting. So at what point do we start to see cuts? And our anticipation is around the first quarter of the year is when the Bank of Canada starts cutting. That being said, I think the risks are still to the upside.
* Some of the data that we are getting in still is pointing to underlying inflationary pressure, namely the strength in the labor market, we got a decent sized job print the other day, and wage growth, which is still running relatively hot at around 5% year over year. So those wage gains kind of put a little bit of a floor underneath the degree to which the Bank of Canada can start discussing rate cuts. But that being said, first quarter is our anticipation.
* OK, so I want to talk about how the markets are right now pricing in potential moves. We have seen some movement in the money markets, in the Bank of Canada's overnight rate. How do you interpret that? What are they saying?
* And I think it's actually consistent with what I was just talking about. Markets are still really on the fence in terms of when that first cut happens. So the March meeting, you're starting to see sentiment turn into just on the cusp of a rate cut. They're putting the chances at about 38%, which is not high.
* But that's the first kind of opportunity, I think, that markets are pricing in for a rate cut. But that's really going to be dependent on what the growth trajectory does look like. If the fourth quarter comes in significantly weak, as folks anticipate, and if the emerging evidence is that the first quarter is going to follow suit, then that gives them room to make that first cut.
* But I think markets are kind of hedging their bets and thinking the risks are still to the upside. And I think if you look at the US, where growth is kind of a little more resilient, consumers are a little more resilient, you take that as evidence that those upside risks are still at least present.
* OK. Now, the next Bank of Canada rate announcement is not till January. What are some of the indicators you'll be watching closely as the Bank of Canada considers its next move?
* Yeah. So it's really going to be, where do those underlying inflationary pressures come from? We've seen the volatile stuff sort of come in-- like oil prices, gasoline, all that kind of stuff. But the underlying price growth, which is going to come from wage gains, services inflation, services spending-- a lot of things now around the consumer.
* Most notably, I would note that we're still looking to the degree to which higher interest rate hikes start to feed into those consumer spending numbers. So as more people are renewing their mortgages into those higher interest rates, what kind of impact does that have? We're really testing the bounds of how much excess liquidity was built into the system after COVID, which we saw a huge surge because of government stimulus.
* But we've been slowly winding that down. How much is left? And what impact are those higher rates going to have? That's kind of the big question right now.
* OK. The final question is, where do you see the Canadian dollar going over the next little while?
* Yeah. It's a great question. Right now, we're still in a very weak space simply because the interest rate differential relative to the US is still quite high. And as I mentioned earlier, the data that we're seeing in the US is still a little bit stronger than it is in Canada. So while we're anticipating a very similar pathway for the Federal Reserve, until that interest rate differential starts to come in, we're likely not to see the Canadian dollar recover too, too much. So it'll be a slow, long recovery back to some normalcy through at the end of our forecast horizon, likely out to 2025 by the time we see a normal level for the CAD.
* Francis, thanks very much for joining us.
* It's been a pleasure, Anthony.
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