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Canada’s inflation rate slowed to 2.7% in April, raising expectations of a potential rate cut by the Bank of Canada in the coming months. Robert Both, Senior Macro Strategist at TD Securities, looks at what the inflation reading could mean for monetary policy and the economy.
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Canada's inflation picture got a little clearer today. Now, according to Statistics Canada, the inflation rate for April slowed to 2.7%, compared to a reading of 2.9% in March. So what does it all mean for the Bank of Canada interest rates and this battle we've been fighting against inflation? Robert Both, senior macro strategist at TD Securities, here with more.
Robert, great to have you here, particularly on a day like this. First, let's break down the report. What stood out for you?
Thanks, Greg. Always a pleasure to be back in the studio. Now, when we looked at the April CPI data, from a high level, things look to be evolving in line with expectations. Headline inflation came down to 2.7%. That was in line with the market consensus-- prices up 0.5% month over month.
Now, if you look at what drove that month-over-month increase, a lot of the strength we saw between March and April was just gasoline prices. You strip those out, and the picture starts to look a lot brighter. Those core measures that the Bank of Canada puts a lot more weight on, those actually came in a little bit lower than expected. So the two that the Bank of Canada puts the most weight on were about 2.75% on average.
Now, that does continue that path lower that we've seen since early this spring. The Bank of Canada does want to see more evidence that that deceleration has been sustained. So at a high level, they are getting more evidence with this report. It's just, perhaps, not as decisive as we would have liked to see if we were, in fact, looking for the Bank of Canada to cut rates next meeting. So while this is all welcome news, we think they are going to want to see a little more evidence before they're willing to take that next step.
And that next meeting just around the corner. I think it's June 5-- first week of June, at least, whenever that Wednesday falls. And you're saying so, perhaps, not as decisive. And it's not just inflation, right? This inflation report moving in the right direction. We've had a few other economic indicators that are saying maybe the economy is a bit stronger than we think.
Certainly. So the Bank of Canada has been trying to balance some evidence of softer inflation pressures with signs that economic activity might be picking up as well. So we saw the April jobs data was much stronger than expected-- 90,000 jobs during the month. And I think, more importantly than the job numbers, which can be quite volatile, is that just the hours worked component was up 0.8% month over month.
So that suggests that some of the stronger economic momentum we've seen in the first quarter might be bleeding into Q2 as well. And while the Bank of Canada is going to be very pleased to see this continued deceleration in both headline and core inflation, if that activity data continues to print stronger than expected, there is a risk that inflation progress stalls above the 2% target. And that is a risk that the bank is going to be monitoring very closely as we approach that June 5 meeting.
Now, jobs are a pretty good indicator of how strong an economy is. You start talking about what the actual GDP number might be looking at and perhaps running a bit above where we thought-- do we get another GDP report before the Bank of Canada gets to decide in June?
We will. And that is going to be the last major data point we get before that June BOC decision. So we'll be getting the Q1 GDP report next Friday. That is during the Bank of Canada's media blackout period. And that is going to tell us whether or not the Canadian economy is still slowing under the weight of higher interest rates or whether we have seen some stabilization there.
Certainly, the monthly data for January and February was quite strong. We're expecting that to come off in the month of March. But that report is also going to give us some insight into April as well. So that will help tell us whether this January, February strength is a one-off or whether some of that doom and gloom has been, perhaps, overstated and, perhaps, there is a little more momentum in the Canadian economy than we anticipated.
I think it's widely agreed upon that where interest rates are right now, where the bank has its trend-setting rate, is restrictive territory. Is it a bit surprising that we've been in restrictive territory for this long, yet this is still the kind of economic numbers and the jobs numbers we're posting?
It's a little surprising at a high level. At the same time, we have been putting more and more emphasis on per-capita levels of GDP growth over the last year, year and a half. And when you look through the impact of stronger population growth, that true per-capita picture does fit with an interest rate environment that is quite restrictive. We are seeing that slowdown materialize on a per-capita basis.
But, certainly, the acceleration we've seen over Q1, and if that were to continue into Q2, that would raise some alarm at the Bank of Canada. And that might see them pump the brakes a little bit on easing rates over the near term.
Let's talk about that. A June meeting coming up in the first week of June, then a July meeting after that-- how are you seeing all this unfold when you put all that together?
So we would have liked to see a more decisive move lower in core inflation for the bank to go in June. That's not to say that there is no risk. It is looking to be a very, very close decision. But as we've discussed, there are some signs that near-term growth might be a little stronger than anticipated.
We're also seeing stronger wage growth. We're seeing wage and inflation expectations that haven't quite returned to those pre-pandemic levels. So overall, we're looking at this upcoming BOC decision as the bank weighing the risks of going too soon versus going too late.
Now, we still think the risk of going too soon is larger, given the risk that inflation stalls north of that 2% target. We think that just waiting an extra six weeks until July would give the bank a lot more clarity on where those inflation pressures are headed into the second half of the year and just how durable is that increase in activity we've seen over the early months of 2024.
If July does become the meeting where they actually deliver an interest rate cut, after that, what would you expect the trajectory to look like?
So we're looking for the Bank of Canada to cut rates by 100 basis points over the rest of the year. So that's a 25 basis point cut in July, and that's 25 basis points at every meeting from July until December. Now, the markets are not looking for quite that degree of easing.
And one of the arguments we've heard from that is, well, if the US is so strong, there is a limit to how far the Bank of Canada can cut ahead of the Fed. We think some of those fears might be overblown, especially as we look to the upcoming BOC decisions. But that will be, certainly, a topic of discussion over the rest of the year as well.
That's the divergence argument, right-- that at some point, our two central banks, as influential as the Americans are, will diverge, but they can only diverge, at least from the Bank of Canada's point of view, so much.
Right. So we think there is quite a bit of scope for the Bank of Canada to diverge from the Fed over the near term. Historically, if you look back since the global financial crisis or the period heading into it, the Bank of Canada and the Fed have diverged by as much as 100 basis points, measuring the overnight rate to the upper bound of the Fed funds rate.
We're currently operating about 50 basis points below the Fed. So we think the Bank of Canada can cut at least two more times before that divergence really starts to make its presence felt. At the end of the day, the depreciating currency is going to be what determines the Bank of Canada's ability to diverge.
As markets price in more divergence between the two, the Canadian dollar is going to come under pressure. That's going to raise the cost of imported goods. That's going to provide a little stimulus to the manufacturing sector. So as all of that comes into play, we're going to get a truer picture of just how far the Bank of Canada can move from the Fed.
But in our base case, we've got the Bank of Canada cutting four times over the second half of this year, the Fed cutting twice. So we expect that we are going to be up against those historical divergence limits, if you will, from December pretty much all the way through 2025. [AUDIO LOGO]
[MUSIC PLAYING]
Canada's inflation picture got a little clearer today. Now, according to Statistics Canada, the inflation rate for April slowed to 2.7%, compared to a reading of 2.9% in March. So what does it all mean for the Bank of Canada interest rates and this battle we've been fighting against inflation? Robert Both, senior macro strategist at TD Securities, here with more.
Robert, great to have you here, particularly on a day like this. First, let's break down the report. What stood out for you?
Thanks, Greg. Always a pleasure to be back in the studio. Now, when we looked at the April CPI data, from a high level, things look to be evolving in line with expectations. Headline inflation came down to 2.7%. That was in line with the market consensus-- prices up 0.5% month over month.
Now, if you look at what drove that month-over-month increase, a lot of the strength we saw between March and April was just gasoline prices. You strip those out, and the picture starts to look a lot brighter. Those core measures that the Bank of Canada puts a lot more weight on, those actually came in a little bit lower than expected. So the two that the Bank of Canada puts the most weight on were about 2.75% on average.
Now, that does continue that path lower that we've seen since early this spring. The Bank of Canada does want to see more evidence that that deceleration has been sustained. So at a high level, they are getting more evidence with this report. It's just, perhaps, not as decisive as we would have liked to see if we were, in fact, looking for the Bank of Canada to cut rates next meeting. So while this is all welcome news, we think they are going to want to see a little more evidence before they're willing to take that next step.
And that next meeting just around the corner. I think it's June 5-- first week of June, at least, whenever that Wednesday falls. And you're saying so, perhaps, not as decisive. And it's not just inflation, right? This inflation report moving in the right direction. We've had a few other economic indicators that are saying maybe the economy is a bit stronger than we think.
Certainly. So the Bank of Canada has been trying to balance some evidence of softer inflation pressures with signs that economic activity might be picking up as well. So we saw the April jobs data was much stronger than expected-- 90,000 jobs during the month. And I think, more importantly than the job numbers, which can be quite volatile, is that just the hours worked component was up 0.8% month over month.
So that suggests that some of the stronger economic momentum we've seen in the first quarter might be bleeding into Q2 as well. And while the Bank of Canada is going to be very pleased to see this continued deceleration in both headline and core inflation, if that activity data continues to print stronger than expected, there is a risk that inflation progress stalls above the 2% target. And that is a risk that the bank is going to be monitoring very closely as we approach that June 5 meeting.
Now, jobs are a pretty good indicator of how strong an economy is. You start talking about what the actual GDP number might be looking at and perhaps running a bit above where we thought-- do we get another GDP report before the Bank of Canada gets to decide in June?
We will. And that is going to be the last major data point we get before that June BOC decision. So we'll be getting the Q1 GDP report next Friday. That is during the Bank of Canada's media blackout period. And that is going to tell us whether or not the Canadian economy is still slowing under the weight of higher interest rates or whether we have seen some stabilization there.
Certainly, the monthly data for January and February was quite strong. We're expecting that to come off in the month of March. But that report is also going to give us some insight into April as well. So that will help tell us whether this January, February strength is a one-off or whether some of that doom and gloom has been, perhaps, overstated and, perhaps, there is a little more momentum in the Canadian economy than we anticipated.
I think it's widely agreed upon that where interest rates are right now, where the bank has its trend-setting rate, is restrictive territory. Is it a bit surprising that we've been in restrictive territory for this long, yet this is still the kind of economic numbers and the jobs numbers we're posting?
It's a little surprising at a high level. At the same time, we have been putting more and more emphasis on per-capita levels of GDP growth over the last year, year and a half. And when you look through the impact of stronger population growth, that true per-capita picture does fit with an interest rate environment that is quite restrictive. We are seeing that slowdown materialize on a per-capita basis.
But, certainly, the acceleration we've seen over Q1, and if that were to continue into Q2, that would raise some alarm at the Bank of Canada. And that might see them pump the brakes a little bit on easing rates over the near term.
Let's talk about that. A June meeting coming up in the first week of June, then a July meeting after that-- how are you seeing all this unfold when you put all that together?
So we would have liked to see a more decisive move lower in core inflation for the bank to go in June. That's not to say that there is no risk. It is looking to be a very, very close decision. But as we've discussed, there are some signs that near-term growth might be a little stronger than anticipated.
We're also seeing stronger wage growth. We're seeing wage and inflation expectations that haven't quite returned to those pre-pandemic levels. So overall, we're looking at this upcoming BOC decision as the bank weighing the risks of going too soon versus going too late.
Now, we still think the risk of going too soon is larger, given the risk that inflation stalls north of that 2% target. We think that just waiting an extra six weeks until July would give the bank a lot more clarity on where those inflation pressures are headed into the second half of the year and just how durable is that increase in activity we've seen over the early months of 2024.
If July does become the meeting where they actually deliver an interest rate cut, after that, what would you expect the trajectory to look like?
So we're looking for the Bank of Canada to cut rates by 100 basis points over the rest of the year. So that's a 25 basis point cut in July, and that's 25 basis points at every meeting from July until December. Now, the markets are not looking for quite that degree of easing.
And one of the arguments we've heard from that is, well, if the US is so strong, there is a limit to how far the Bank of Canada can cut ahead of the Fed. We think some of those fears might be overblown, especially as we look to the upcoming BOC decisions. But that will be, certainly, a topic of discussion over the rest of the year as well.
That's the divergence argument, right-- that at some point, our two central banks, as influential as the Americans are, will diverge, but they can only diverge, at least from the Bank of Canada's point of view, so much.
Right. So we think there is quite a bit of scope for the Bank of Canada to diverge from the Fed over the near term. Historically, if you look back since the global financial crisis or the period heading into it, the Bank of Canada and the Fed have diverged by as much as 100 basis points, measuring the overnight rate to the upper bound of the Fed funds rate.
We're currently operating about 50 basis points below the Fed. So we think the Bank of Canada can cut at least two more times before that divergence really starts to make its presence felt. At the end of the day, the depreciating currency is going to be what determines the Bank of Canada's ability to diverge.
As markets price in more divergence between the two, the Canadian dollar is going to come under pressure. That's going to raise the cost of imported goods. That's going to provide a little stimulus to the manufacturing sector. So as all of that comes into play, we're going to get a truer picture of just how far the Bank of Canada can move from the Fed.
But in our base case, we've got the Bank of Canada cutting four times over the second half of this year, the Fed cutting twice. So we expect that we are going to be up against those historical divergence limits, if you will, from December pretty much all the way through 2025. [AUDIO LOGO]
[MUSIC PLAYING]
