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As it cut its key overnight rate to 4.75%, the Bank of Canada became the first G7 central bank to lower interest rates in the current cycle. Andrew Kelvin, Head of Canada and Global Rates Strategy with TD Securities, speaks with MoneyTalk’s Greg Bonnell about what to expect from the BoC going forward.
Transcript
Greg Bonnell: The Bank of Canada has cut its key interest rate by 25 basis points, becoming the first G7 nation and central bank to begin easing borrowing costs after, of course, that aggressive hiking cycle. Well, our central bank [is] also signaling that more cuts may be ahead.
Joining us now to break it all down, Andrew Kelvin, Head of Canada and Global Rate Strategy with TD Securities. Great to have you back on the program.
Andrew Kelvin: Thanks for having me. Pleasure to be here.
Greg Bonnell: We’ll say right off the top, kudos where kudos are deserved. You made this call ahead of the announcement. Indeed, they did cut. Give us your reaction to what we saw today and the rationale behind the cut.
Andrew Kelvin: Yeah. there wasn’t a lot of surprises, not just with the decision- we did expect a cut, as you note- but also in the way they described the cut. They really did indicate that it’ll probably be a more gradual easing cycle compared to what we saw with the hiking cycle. The rationale for the cut’s pretty straightforward- the data was just there.
Inflation momentum has really been flagging throughout 2024 at the start of the year through an annualized core inflation. So think about your underlying momentum in inflation, where inflation is going, was running in the sort of mid to low-3s. Last two months, it has been below 2%.
So headline inflation has been moving steadily lower. It’s still 2.7%. It’s still pretty high, but not as high as it had been. And it’s within the bank’s 1% to 3% band. And your near-term momentum is pointing towards inflation returning on a more sustainable way to 2%. And that’s really the key.
We’ve seen enough sort of soft-ish CPI prints that they can feel comfortable that this trend will be sustained. And the growth data in the first quarter was not as strong as they had expected. The Bank of Canada had been looking for a 2.8% Q1 GDP print. It came in at 1.7%. And while the details may suggest it was a strong 1.7%, the fact is the BOC was looking for 2.8%.
So, inflation is softening. Growth’s weaker than the BOC expected. That’s the data they need to go to a less restrictive but still restrictive stance. And while there was an argument, I think, to be made for waiting to make extra sure-
Greg Bonnell: Yeah, in your note, you said this persistence and wage growth could have been the thing, if they hadn’t moved, they could have hung their hats on that.
Andrew Kelvin: They could have. And they did address that, actually, in either the statement or the press conference, essentially noting that they are starting to see some signs of moderation in wage growth as well. So, I think it’s a reasonable argument.
The unemployment rate in Canada has increased quite sharply over the last year or so. There’s slack in the labor market. Demand is not as strong as it once was. Wage growth is much more likely to turn to margin compression from businesses than it is to pass through into inflation in this sort of environment. When you have an unemployment rate 6% or above, it does follow that you shouldn’t see the same wage pressures going forward.
So, I think it all makes sense. The data was there for them. There was a route to be, perhaps, extra cautious, which would have had minimal cost to the economy. But at the end of the day, I think they just looked at the economy, supported interest rate cuts, so they cut. I think it’s pretty straightforward.
Greg Bonnell: Yeah. They were pretty clear in saying, listen, if we continue to see the path that we’re on, we’re confident that you can expect more cuts at future meetings. But there’s always risks, right, because they have to go from meeting to meeting and watch it.
So we mentioned the wage growth risk. They listed geopolitics, but also home prices. I think a lot of people have their eye on that one.
Andrew Kelvin: That was really interesting. I was a little bit surprised to see that so explicitly mentioned. That’s usually something we have to dig into an MPR to find out how they’re thinking about home prices. It shows that they are sensitive to what we’re seeing with shelter price inflation.
I think the reality of this is that with there being a big glut of unmet housing demand, which is something that Senior Deputy Governor Rogers did mention in the press conference – given that there is this sort of overhang of demand, we are going to be looking at shelter price inflation that will be above headline inflation probably for quite a long time.
If they can get ex-shelter inflation to be sufficiently below 2%, then you can run with your 2% inflation target with shelter inflation being a bit more persistent. But it is such a big part of the basket. It’s a big part of the basket that can move rapidly in this country, given it’s about a quarter of CPI. If you have a quarter of CPI that can move in leaps and bounds, it clearly represents a threat to achieving your 2% inflation target one way or the other.
Like in the current context we’re talking about with rising house prices, but the same could be true if they were to overtighten, and falling house prices could put them into disinflation pretty quickly as well. That’s obviously not what happened. But those risks over a long enough horizon do become symmetric.
Greg Bonnell: Now, I’m going to ask you a question that Governor Macklem was asked. And I didn’t know he was able to deliver a zinger. Someone said, OK, we’ve got this decision today. What about July? Are we going to cut? Where- are there more cuts? He said, let’s savor the moment. That’s the way he answered the question. What would you think is the next move?
Andrew Kelvin: Well, he answered that on the second time, he was asked about July. So I guess he thought about the first time when he was answering the July question. I think they’ll cut in July.
Historically, it’s very rare for the BOC to go from dormant monetary policy to a new phase of a monetary policy cycle and not move in back-to-back meetings. It’s happened before. It’s not totally unprecedented. The two most recent times I would point to would be prior to the financial crisis the Bank of Canada hiked rates in July of 2007, and the world changed between July and September of 2007. So, clearly, they didn’t follow through.
If you look at Governor Poloz’s insurance cuts when he went from 1% to 75 basis points on the back of the oil crash in the middle of the last decade, he framed those as insurance cuts. I think it’s hard to use that sort of insurance framing today.
And, in fact, of course, the BOC did not frame them as insurance cuts. We now know that they don’t see them that way, which would have been an odd position for the bank to take regardless. So, I don’t really see that as a precedent in either. So I do look for them to cut rates in July.
I would say from the bank’s perspective, cutting in June and July and then waiting to see where you are and taking a pause in September is entirely consistent with the message that the pace of easing will be gradual. I will also add that they did emphasize this is going to be data-dependent.
We have two more CPI prints ahead of that July meeting. If those both come out quite a bit stronger than expected, maybe the Bank of Canada will start having second thoughts about this path they have started on. But I would just say, I think it would be unusual for the bank to not cut rates in July. And I think it would create a communication challenge for them to not cut rates in July, because if they don’t cut in July and they’re not willing to provide explicit guidance-
Greg Bonnell: What are you worried about?
Andrew Kelvin: Exactly. Why would we believe you when you say you expect further rate cuts at that point? When you say you expect further rate cuts, do you mean once every six months? I just think if they were to take a pause immediately after this cut, it would create more challenges than it would produce benefits.
Greg Bonnell: So if we got the June one, if we get a July one, and a pause in September, and inflation continues to move the way they want, how do you see that key benchmark rate by the end of this year?
Andrew Kelvin: So we think we can get two more cuts in the fourth quarter. We do think that by that point, we will have several fairly weak growth quarters behind us – not negative, we’re not talking recession here. Again, the population growth is probably too strong for us to talk about recession on mild activity slowdowns.
But weak enough growth, combined with inflation that will, we think, have been proven to be sustainable at 2%, that we can get a few more rate cuts from the BOC in the fourth quarter. So we think that they will end the year at 4%.
Greg Bonnell: OK. I want to ask you about, obviously, they’re going to be watching the data this Friday. We’re going to get a jobs report. How are you guys seeing this? Is this going to be one of those reports where the Bank of Canada says, Oh, we made the right move this week? Or, like, uh oh, what do we do?
Andrew Kelvin: So jobs reports are notoriously volatile. I think there’s always enough moving parts in a jobs report that you can pick and choose the things that suit a given narrative. The thing I would say is that while job growth has been, at face, quite strong through the first four months of 2024, the population growth has been even stronger.
So, given that we’re looking at an unemployment rate that is above 6% now, we’ve sort of fallen short the breakeven number of jobs by sort of 15,000 to 20,000 per month through 2024, I think it would be very difficult for the Bank of Canada to see a sufficiently large surprise that they had second thoughts about this first round of rate cuts. I think that a jobs number that was quite strong that’s followed by several more strong jobs numbers could filter through to how they think about the latter part of the year.
But at the end of the day, there’s a lot of slack. And the Governor addressed this in the press conference. He did note that given the slack in the economy, there is room for a period of above-trend growth that is consistent with inflation still coming lower. And nowhere is that more evident, to my mind, than in the labor market.
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