The Bank of Canada says it may take longer than expected to get inflation back to its 2% target. Interest rates are now at their highest since 2001. Andrew Kelvin, Head of Canadian and Global Rates Strategy at TD Securities, discusses the central bank’s more hawkish tone.
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* The Bank of Canada has delivered yet another 25 basis-point hike, bumping its trendsetting rate to 5%. That is the highest level since 2001. They're also saying it's going to take longer than first expected to get inflation back to target. A lot going on. Joining us now to discuss, Andrew Kelvin, head of Canadian and global rate strategy with TD Securities. Great day to have you here, but always great to have you on the program.
* And thank you for having me. Pleasure.
* So there's a lot going on here. Let's start to unpack what we're seeing right now. Obviously, you get another hike. You get ourselves up to rates we haven't seen since before I was a homeowner, before I was a father-- it was a long time ago, 2001-- and this expectation that it's going can take longer to get to the end game. Let's start parsing through this. What's the big takeaway?
* I mean, the big takeaway is that rates are 25 basis points higher. I look at today's rate hike as, really, a recognition of the resiliency the economy showed through the first half of 2023. The next half of 2023 will be, I think, a little bit bumpier for the economy because there are some early signs that the bank perhaps didn't pay as much attention to as they expected, but there are some early signs that rate hikes are starting to bring some more balance into the labor market. Households are starting to feel the pinch just a little bit more than they were, perhaps, in March.
* But for the Bank of Canada, they look at the three-month trend of the core inflation metrics. That hasn't been moving lower for the last little while. It's been sort of stuck between 3.5% and 4%. And they had a line in their communique suggesting that if, given the lack of downward momentum in core inflation, the path back to 2% was jeopardized. I'm paraphrasing just a little bit, but they did use the word "jeopardized," which really popped to me.
* So it looked to me that, on balance, while they are cognizant that there needs to be a balance between over and under tightening, they are just a little bit more worried about being able to achieve that price-stability mandate. They are a little bit concerned that they haven't done enough to bring inflation lower, as evidenced by the fact that they don't expect inflation to hit 2% until mid 2025. And so at the end of the day, as much as they might be uncomfortable for the potential lagged effects of the rate hikes already in the system, they did feel like they needed to hike.
* I was in the same as you, as even this prepared statement before Tiff Macklem, the governor, started taking questions after the decision. The words that were popping out to me were "stubborn" and "persistent" when they talk about core. You mentioned them pushing out their target to the middle of 2025. They did say three things that they need to see-- demand growth slowing, wage pressures moderating, and corporate pricing behavior normalizing. Let's unpack those three things. Are we starting to see any of that on any of those fronts?
* I think we are, certainly on the wage pressures. We have seen the unemployment rate increasing in the last two reports. The most recent labor-force survey showed a little bit of a moderation in average hourly wages, more than it was expected. When the Bank of Canada talks about wage growth being between 4% and 5%, I really emphasize it's closer to the 4% than the 5% now. We are seeing sort of broader measures of wage pressures show some moderation, so that's a good sign.
* Now, on the corporate pricing behavior, most businesses do expect to see slower-output price inflation in the coming years, as based on the Bank of Canada's own surveys, than past years. But they also acknowledge that some businesses haven't fully passed on some of the recent cost increases through to consumers. Therefore, businesses will be operating in an environment of higher-than-normal output costs-- good cost increases. So the bank is watching that. But again, we are seeing, at least if we believe these surveys, signs of progress there.
* And on the demand side, this really has to come back to the household sector. Debt service ratios in the most recent readings for the first quarter are sharply higher. The Bank of Canada is watching this. They had a big box on the health of the household sector. They think that most households have more in the way of liquid assets to buffer against increases in interest costs and inflation, these sorts of things, which fits with that sort of excess-savings discussion we've had.
* But I think if you put it to most Canadian households, they wouldn't tell you they're sitting on a whole bunch of excess savings. And I do think with debt service costs rising, we will start to see households be a little bit more cautious in their spending behavior through the latter part of this year.
* All right, I'm going to ask you a question that Tiff Macklem actually asked of himself. He said he knows that many Canadians are asking, is the bank done raising interest rates? Or will rates need to go higher to still relieve price pressures? Shorter answer is, meeting by meeting, decision by decision. But if they see a reason to go again, they will. Do you think they're done at 5%?
* I do think they're done at 5%. The onus is on the data to disappoint here. If the economy starts to show signs of slowing-- if the demand in the economy starts to show signs of slowing in the next few months, the Bank of Canada may be comfortable taking a wait-and-see approach when it comes time to make their decision in September.
* In an environment where high interest rates are just going to have increasing impacts on the economy, I am of the view that the next pause, whenever that comes, will be the last pause, as it were. And our view is that with growth likely to slow, the Bank of Canada will probably be able to stay on hold in September. And once we get into the latter part of the year-- it is our expectation that we will see inflation come lower a little bit more quickly in the BOC. It will still take a long time to hit 2%, but we think it will be before the middle part of 2025.
* And we think ultimately, the BOC will be comfortable with the idea that rates at 5% are enough. But what I would suggest is that just because the Bank of Canada may be done hiking here, it doesn't mean rate cuts are around the corner.
* I wanted to ask you about that because if they don't think that they can get inflation back to 2% by the middle of 2025-- you think perhaps they're pushing a little further. Do they need to see it hit 2% before they start to cut? Because by their own words, they're in restrictive territory right now. Do they have to wait for that moment?
* It doesn't need to hit 2%, but it needs to be very clearly on the path to 2%. I go back to this idea that the sort of trend underlying inflation is between 3.5% and 4%. That needs to be at 2%. So you need to be on a very clear path to 2% if you have your sort of underlying inflationary pressures operating at a two-month annualized pace over a one- or two-quarter period, and you have headline inflation that's falling rapidly. It certainly, I think, would have to be below 3% for the Bank of Canada to be able to credibly ease in an environment where we have been overshooting their 2% target for so, so long.
* I think it would be very difficult for the bank to say, OK, I know inflation is running around 3.5%, but hey, look, we're pretty sure it's going to 2%, so we'll cut rates. That's very difficult. The other thing that needs to happen is we do need to see that slowing in demand that they talk about. We need to see a higher unemployment rate. We need to see more slack in the labor market for the Bank of Canada to be able to cut rates.
* A lot going on in this, but we are talking central banks. We are talking inflation at the core of all this. We actually got the latest read on US consumer price pressures this morning. How did you read through that and what it might mean for the Fed later this month?
* It was a little bit softer than expected, certainly. I do think another Fed hike is still on the table here. I think what this speaks to is the idea that we are quite late in the cycle.
The fact that we are seeing a little bit more moderation in inflation in the US is consistent with the idea that this hike in July could be the last hike from the Fed. And I would just put forward that the Fed doesn't have some of the same demand drivers facing them that the Bank of Canada has. * So when we do start talking about rate cuts, whenever that may be-- we do think it will be March for the Fed, I should say-- it will come more quickly in the US.
* March, 2024.
* 2024, sorry. Yeah, it won't happen in the past.
* I just want to make sure now we're not talking about 2025 now that the Bank of Canada has thrown us that far in the future.
* Thank you very much. I've been confused with dates all day. That's going to happen. It is something that will be a conversation we have more quickly in the US than we do in Canada. I think that's the point I want to emphasize here-- in a way that doesn't require me to actually recite dates.
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* The Bank of Canada has delivered yet another 25 basis-point hike, bumping its trendsetting rate to 5%. That is the highest level since 2001. They're also saying it's going to take longer than first expected to get inflation back to target. A lot going on. Joining us now to discuss, Andrew Kelvin, head of Canadian and global rate strategy with TD Securities. Great day to have you here, but always great to have you on the program.
* And thank you for having me. Pleasure.
* So there's a lot going on here. Let's start to unpack what we're seeing right now. Obviously, you get another hike. You get ourselves up to rates we haven't seen since before I was a homeowner, before I was a father-- it was a long time ago, 2001-- and this expectation that it's going can take longer to get to the end game. Let's start parsing through this. What's the big takeaway?
* I mean, the big takeaway is that rates are 25 basis points higher. I look at today's rate hike as, really, a recognition of the resiliency the economy showed through the first half of 2023. The next half of 2023 will be, I think, a little bit bumpier for the economy because there are some early signs that the bank perhaps didn't pay as much attention to as they expected, but there are some early signs that rate hikes are starting to bring some more balance into the labor market. Households are starting to feel the pinch just a little bit more than they were, perhaps, in March.
* But for the Bank of Canada, they look at the three-month trend of the core inflation metrics. That hasn't been moving lower for the last little while. It's been sort of stuck between 3.5% and 4%. And they had a line in their communique suggesting that if, given the lack of downward momentum in core inflation, the path back to 2% was jeopardized. I'm paraphrasing just a little bit, but they did use the word "jeopardized," which really popped to me.
* So it looked to me that, on balance, while they are cognizant that there needs to be a balance between over and under tightening, they are just a little bit more worried about being able to achieve that price-stability mandate. They are a little bit concerned that they haven't done enough to bring inflation lower, as evidenced by the fact that they don't expect inflation to hit 2% until mid 2025. And so at the end of the day, as much as they might be uncomfortable for the potential lagged effects of the rate hikes already in the system, they did feel like they needed to hike.
* I was in the same as you, as even this prepared statement before Tiff Macklem, the governor, started taking questions after the decision. The words that were popping out to me were "stubborn" and "persistent" when they talk about core. You mentioned them pushing out their target to the middle of 2025. They did say three things that they need to see-- demand growth slowing, wage pressures moderating, and corporate pricing behavior normalizing. Let's unpack those three things. Are we starting to see any of that on any of those fronts?
* I think we are, certainly on the wage pressures. We have seen the unemployment rate increasing in the last two reports. The most recent labor-force survey showed a little bit of a moderation in average hourly wages, more than it was expected. When the Bank of Canada talks about wage growth being between 4% and 5%, I really emphasize it's closer to the 4% than the 5% now. We are seeing sort of broader measures of wage pressures show some moderation, so that's a good sign.
* Now, on the corporate pricing behavior, most businesses do expect to see slower-output price inflation in the coming years, as based on the Bank of Canada's own surveys, than past years. But they also acknowledge that some businesses haven't fully passed on some of the recent cost increases through to consumers. Therefore, businesses will be operating in an environment of higher-than-normal output costs-- good cost increases. So the bank is watching that. But again, we are seeing, at least if we believe these surveys, signs of progress there.
* And on the demand side, this really has to come back to the household sector. Debt service ratios in the most recent readings for the first quarter are sharply higher. The Bank of Canada is watching this. They had a big box on the health of the household sector. They think that most households have more in the way of liquid assets to buffer against increases in interest costs and inflation, these sorts of things, which fits with that sort of excess-savings discussion we've had.
* But I think if you put it to most Canadian households, they wouldn't tell you they're sitting on a whole bunch of excess savings. And I do think with debt service costs rising, we will start to see households be a little bit more cautious in their spending behavior through the latter part of this year.
* All right, I'm going to ask you a question that Tiff Macklem actually asked of himself. He said he knows that many Canadians are asking, is the bank done raising interest rates? Or will rates need to go higher to still relieve price pressures? Shorter answer is, meeting by meeting, decision by decision. But if they see a reason to go again, they will. Do you think they're done at 5%?
* I do think they're done at 5%. The onus is on the data to disappoint here. If the economy starts to show signs of slowing-- if the demand in the economy starts to show signs of slowing in the next few months, the Bank of Canada may be comfortable taking a wait-and-see approach when it comes time to make their decision in September.
* In an environment where high interest rates are just going to have increasing impacts on the economy, I am of the view that the next pause, whenever that comes, will be the last pause, as it were. And our view is that with growth likely to slow, the Bank of Canada will probably be able to stay on hold in September. And once we get into the latter part of the year-- it is our expectation that we will see inflation come lower a little bit more quickly in the BOC. It will still take a long time to hit 2%, but we think it will be before the middle part of 2025.
* And we think ultimately, the BOC will be comfortable with the idea that rates at 5% are enough. But what I would suggest is that just because the Bank of Canada may be done hiking here, it doesn't mean rate cuts are around the corner.
* I wanted to ask you about that because if they don't think that they can get inflation back to 2% by the middle of 2025-- you think perhaps they're pushing a little further. Do they need to see it hit 2% before they start to cut? Because by their own words, they're in restrictive territory right now. Do they have to wait for that moment?
* It doesn't need to hit 2%, but it needs to be very clearly on the path to 2%. I go back to this idea that the sort of trend underlying inflation is between 3.5% and 4%. That needs to be at 2%. So you need to be on a very clear path to 2% if you have your sort of underlying inflationary pressures operating at a two-month annualized pace over a one- or two-quarter period, and you have headline inflation that's falling rapidly. It certainly, I think, would have to be below 3% for the Bank of Canada to be able to credibly ease in an environment where we have been overshooting their 2% target for so, so long.
* I think it would be very difficult for the bank to say, OK, I know inflation is running around 3.5%, but hey, look, we're pretty sure it's going to 2%, so we'll cut rates. That's very difficult. The other thing that needs to happen is we do need to see that slowing in demand that they talk about. We need to see a higher unemployment rate. We need to see more slack in the labor market for the Bank of Canada to be able to cut rates.
* A lot going on in this, but we are talking central banks. We are talking inflation at the core of all this. We actually got the latest read on US consumer price pressures this morning. How did you read through that and what it might mean for the Fed later this month?
* It was a little bit softer than expected, certainly. I do think another Fed hike is still on the table here. I think what this speaks to is the idea that we are quite late in the cycle.
The fact that we are seeing a little bit more moderation in inflation in the US is consistent with the idea that this hike in July could be the last hike from the Fed. And I would just put forward that the Fed doesn't have some of the same demand drivers facing them that the Bank of Canada has. * So when we do start talking about rate cuts, whenever that may be-- we do think it will be March for the Fed, I should say-- it will come more quickly in the US.
* March, 2024.
* 2024, sorry. Yeah, it won't happen in the past.
* I just want to make sure now we're not talking about 2025 now that the Bank of Canada has thrown us that far in the future.
* Thank you very much. I've been confused with dates all day. That's going to happen. It is something that will be a conversation we have more quickly in the US than we do in Canada. I think that's the point I want to emphasize here-- in a way that doesn't require me to actually recite dates.
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