With inflation rising to 4% in August, will the Bank of Canada need to hike interest rates again? MoneyTalk’s Greg Bonnell discusses with Robert Both, Macro Strategist with TD Securities.
Greg Bonnell: Well, higher gasoline prices pushed inflation to 4% in August. But will the Bank of Canada be able to look through this acceleration in energy costs and keep interest rates on hold? Joining us now to discuss, Robert Both, Macro Strategist at TD Securities. Robert, welcome back to the program.
Robert Both: Thank you, Greg. It’s always a pleasure to be back and to be able to discuss the outlook for the Bank of Canada and what Canadians can expect going forward.
Greg Bonnell: Okay, so let’s talk about that headline inflation to begin with. We had it sub-3% heading into the summer and a reacceleration on gasoline prices. 4%, I think, was a little bit hotter than most people were expecting. How do you read it?
Robert Both: That’s right. It was only two months ago that inflation was actually 2.8% year-over-year. Now, at the time we knew that inflation was going to move higher because of base effects that were caused by energy prices falling last year. However, the last two months have been much stronger than we or the market had anticipated.
So instead of getting back to about 3.5% year-over-year, inflation is now running at 4%. It was up 7/10ths from the 3.3% rate in July and just the month-over-month increase, both the headline index and measures of core inflation rising about 0.4 month-over-month. So this wasn’t just an energy price story like we and some others had anticipated. It does seem to be a little bit more broadly based than that. And that is going to concern those at the Bank of Canada, who have been highly concerned with the persistence of price pressures.
Greg Bonnell: Yeah, because the headline is one thing, it’s pushed around, you said, by volatile things like gasoline prices. But if you’ve got core running at 4% as well, I think you guys put out a note this morning saying this isn’t comfortable for the bank.
Robert Both: No, it’s not going to make the Bank of Canada more comfortable. So even though we did see large contributions from gasoline, from heating fuels, electricity, inflation pressures were much more broadly based than that. We saw rent prices rebound a little bit. We saw more strength come through the mortgage interest channel.
And then you also saw a little more pressure from some of those consumer goods that had been decelerating over the last few months. So things like clothing, furniture, appliances, parts of the economy where spending has been trending lower over the last few months, all of a sudden price pressures are starting to reemerge there. And that’s what helped drive the rebound in core inflation measures.
Greg Bonnell: Now apart from inflation, we had seen an economy come in weaker in the second quarter than expected, perhaps some cooling in the labor market off of its rather hot pace. We start taking all these things and mixing them together. We don’t get another rate decision, I think, from the bank till next month. What do they need to be looking at heading into that one?
Robert Both: You’re right. So the next Bank of Canada meeting will be towards the end of October. So there is still a period where they can evaluate incoming data to decide whether or not the inflation shock warrants potentially moving higher from 5%. In particular, we’ll be watching the next monthly GDP report, which we’ll get next Friday. That’s July data. It’ll also give us an early look at economic activity in August.
We’ll also get one more inflation report for the month of September, and then the last one we’re going to get before the next Bank of Canada meeting, which the bank will be keenly focused on as well, are those Q3 business outlook survey and consumer surveys, as well. So those just give us a better read on sentiment across Canada.
Greg Bonnell: As I was looking through the TD Securities note about all of this in the print we got this morning, this line stood out for me. “If the next CPI print is higher or at these levels, we have a hike warming up in the bullpen for October.” So we actually think we’re at the place now where if the data keeps moving the other way, the Bank of Canada will go again.
Robert Both: Well, I don’t think it’s entirely up to the next inflation print. I wouldn’t put that much emphasis on it, because we have seen more signs of slowing come through the growth channel over the last couple of months, and especially with that second quarter national accounts.
So I think when you are seeing the interest rates that have been delivered already having a more significant impact on growth, that does give us a little more confidence that inflation will break lower with time. But these upward shocks do provide some counterevidence to that. And there is going to be a limit to how much the Bank of Canada can tolerate.
Now, if inflation proves more persistent, and we see growth rebounding as well over the second half of this year, if that Q2 shock does look a little more like a one-off, then I would be more concerned about the prospects for another round of Bank of Canada tightening. But I think they will take a more comprehensive look at the data over the next six weeks or so, rather than simply the next inflation report.
Greg Bonnell: Over the past year and a half, this has been at a very aggressive pace of rate hikes, not just from our central bank, but from other G7 banks, the Fed as well. What is it that’s happening here that we’re not getting inflation coming? I mean, is it — the energy prices are external. We start talking about OPEC. Are there forces outside of our borders that, even though we keep hiking the borrowing cost on us Canadians, us consumers, you’re just not getting inflation where you want it to get?
Robert Both: So that’s something that Governor Macklem actually discussed in his most recent speech. It’s taken a little bit longer than we’d anticipated for rate hikes to hit economic growth. And just like it took longer than expected for that to occur, it’s also taking longer for slower growth to translate into less inflation pressures.
Now, one place I would look at right now is the labor market. So we have seen some evidence of rebalancing in the labor market. The unemployment rate is about 0.6 percentage points higher than its cycle low. It’s getting close to those levels where it’s no longer putting upward pressure on wage growth. But the labor market is still exceptionally tight.
If you look at job vacancies, the vacancy rate is still above pre-COVID levels. But we have seen it move closer to balance over the last 12 months. And once it does get there, I think we can have more confidence that we’re not adding inflation pressures domestically. The Bank of Canada has much more scope to look through external inflation shocks than building excess demand, which was a key driver of the inflation we saw over the second half of 2021 and first half of 2022.