The Canadian inflation report came in at 6.9% in October, matching September’s reading. Robert Both, Macro Strategist at TD Securities, spoke with Greg Bonnell to explain why interest rates may still need to move higher, but at a slower pace than before.
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[MUSIC PLAYING] The latest Canadian CPI report showing that while inflation remains at elevated levels, it held steady in October at 6.9%. Well, our featured guest today says that data could give some ammunition for both the hawks and the doves. Joining us now is Robert Both, a macro strategist at TD Securities. Great to have you on the program. Let's talk about what we got today. Obviously, everyone's watching inflation prints very carefully. What did you make of it? Thank you, Greg. Well, it's my pleasure to be here. In terms of today's inflation print, as you mentioned, it was in line with the market consensus at 6.9%. Prices rose by 0.7% month over month. And I think there are a couple of important takeaways from this. The first is that with a 6.9 inflation rate in October, we're probably tracking somewhere below where the Bank of Canada had predicted inflation would be in Q4. So their last monetary policy report from October had a 7.1 projection for the fourth quarter. With today's data, we think that could come in somewhere between 6.9% and 7%. While that's still very high, it does speak to things moving in the right direction. The second point is that inflation is just still far too high for comfort here, especially with the core inflation measures ticking higher from September. The two that the Bank of Canada looks most closely at are the trimmed mean and weighted median inflation measures. And those both rose by a tenth of a percent. So while things are moving in the right direction, perhaps they're not moving as quickly as we'd like to see. And that core inflation rate does suggest that inflation could remain a little more sticky, and that it might take a little more time to see headline move materially lower. There were a couple other promising elements of the report, though. The services inflation registered a fairly small month-over-month increase. And this has been the big concern, right? It's one thing for these volatile elements, like energy and food, which can shift pretty quickly. But the fear was once it gets into the services part of the economy, that's going to be harder to tame. So walk us through the services part. That's correct. So in services what we're seeing is a bit of an offset from some of the other pressures coming through the shelter component. So within a shelter, you have two subcomponents that are sensitive to house prices versus the homeowner replacement cost, which simply tracks the cost of new construction in Canada. And then, there is another one called the other owned accommodation expense. That includes things like the closing cost on a new house. And as a result of that, it tracks house prices more broadly. Those are offsetting some of the other, more inflationary parts of the service sector. Together, they do point to a slowing rate of change, though. And also, the ex food and energy measure, which is what the US uses for their primary core inflation, that registered one of its smallest increases since last year. So overall, you've seen a bit of a mixed signal from this one. So as you said, there is something for the hawks and the doves. Depending on how you see the world, you find what you want in this report. When it comes to the Bank of Canada, obviously, the last time we heard from them, they took their foot off the gas a little bit. I mean, it's been a year of super-sized rate hikes. So they pulled it off just a little bit. How does this set them up for the December meeting? So it's a very interesting backdrop to the December meeting. Right now, the market is priced for roughly halfway between a 25 basis point rate hike and a 50 basis point rate hike. That didn't change after today's CPI decision. So we're still sort of sitting on the fence here from the market's perspective with some hawkish and dovish elements. The increase to the Bank of Canada's core measures versus the month over month change in services, and that ex food and energy-- it allows people to sort of pick their narrative. And as a result, the market more or less looked past this one. We find ourselves in the camp that a 25 basis point rate hike is more prudent for the December BOC meeting. Even after the 50 basis point hike last month, in October, that was smaller than expected. Rates are still well into restrictive territory here. We are seeing signs of slowdown in other parts of the economy, those interest-sensitive parts that Governor Macklem has referenced. So I think the risk/reward approach does favor a more cautious path forward. We look for a 25 basis point rate hike in December and one more 25 basis point hike in January to top things out at 4.25%. Is there a sense out there now, too, that the Bank of Canada and maybe even the Fed-- they're trying to be a little more forward looking? They realize that monetary policy works with a lag. They have done a lot so far. They need to start thinking about where inflation is a year from now, 18 months from now, where the economy is further. So does that make the backward looking data points not as important as perhaps they were in the summer. Because we really jumped every time we got any kind of data point. And the data is always backward looking to a certain degree. Yeah. I think that's a fair point to make. You know, the Bank of Canada has been talking about front-loading this rate hike cycle. We saw that with 100 basis points in June. We've seen 75 and 50 basis point hikes since. You know, now that rates are well above their neutral range, it does make sense to put a little more weight on the forward-looking indicators. Even our latest quarterly GDP prints, that was Q2, and that feels like a very long time ago. Interest rates were much lower back then. Traditionally, rate hikes have taken anywhere between one and two years to actually show up on the demand side. So I think they do have to take a little more of a finely balanced approach going forward to use the Governor's own words. Of course, the big question to-- whether you're talking about our central bank or the US Federal Reserve-- is once they reach the point where they feel that they can stop, how long are they going to stay there? The move up has been very dramatic this year. And anyone with any kind of loan that is tied to that rate is feeling that. I guess they're probably wondering now, when does it end? And then, how long do I stay at this level. Right. I think that depends on a few factors. First and foremost is the inflation outlook. So the bank is going to have to see clear signs that inflation expectations remain anchored and that inflation is well on a downward path before they look at taking back some of these rate hikes. You know, that inflation outlook, in turn, depends on developments in the global economy, some of the supply disruptions that have wreaked havoc across the goods producing sector over the last year or two, and then how the Canadian economy responds to the rate hikes that they've delivered so far. And, as I mentioned, we are starting to see evidence that those rate hikes are starting to have an effect on the labor market, on certain industries on the GDP side. So we're looking at somewhere in the-- when CPI returns to the 3% area, if inflation expectations remain anchored, we think the Bank of Canada can begin bringing rates back to a neutral stance, so not actually providing accommodation but just taking their foot off the brake a little bit. We think that's unlikely to occur until the first quarter of 2024. So we think we'll be at that 4.25% rate for about 12 months.
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