ANALYSIS: Bank of Canada Still in Rate-Hike Mode as Recession Indicators Mount

Bank of Canada governor Tiff Macklem speaks at a news conference following an interest rate announcement, in Ottawa on Oct. 25, 2023. The central bank held its policy rate at 5 percent on Dec. 6, 2023. (The Canadian Press/Adrian Wyld)

OTTAWA—The Bank of Canada in its Dec. 6 rate announcement painted a picture of a worsening economy but not one that needs a cut in interest rates quite yet. The central bank pointed to a few ongoing areas of strength and concern, saying it “remains prepared to raise the policy rate further if needed.” 

But economists don’t see a need for further rate hikes as recessionary conditions build. A key measure of worry cited is gross domestic product (GDP) on a per capita basis, which Oxford Economics (OE) noted has been in a recession since late 2022.

Closely related to this is productivity, which has declined for a sixth consecutive quarter, as reported by Statistics Canada on Dec. 6.

“I was hoping [for] that vocabulary around ‘we’re ready to raise rates once again’ not being there because clearly, from my point of view and from most people’s point of view, there’s little to no signs that the Canadian economy needs further rate hikes,” David-Alexandre Brassard, chief economist of Chartered Professional Accountants of Canada, told The Epoch Times on Dec. 6.

He said it would be odd to hike rates further when the inflation problem is mainly in housing costs where higher rates lead to higher costs. Year-over-year mortgage interest costs were rising by over 30 percent in the summer.

“There’s a strange dissonance in the fact that they’re mentioning they’re ready to hike again to control inflation on which rates will have little impact,” Mr. Brassard said.

BMO chief economist Doug Porter said in a Dec. 6 note that markets are pricing in rate cuts even if the BoC is clearly not entertaining them presently.

“Maintaining the hiking bias is likely driven entirely by a desire to continue dampening Main Street inflation expectations and keeping a lid on housing speculators, even as markets are pricing in more than 100 bps [1 percentage point] of cuts next year,” he said.

OE’s director of Canada Economics Tony Stillo said in a Dec. 6 note that the Canadian economy slipped into a moderate recession in the third quarter and that it will likely last through the first quarter of 2024.

“We think further rate hikes are unnecessary as slack continues to build during the recession,” he said.

Core Problems

But while the phrase “inflationary risks have increased” from the central bank’s Oct. 25 statement was not to be found in the December statement, the BoC said it wants to see “further and sustained easing in core inflation.”

Overall inflation has fallen from 5.9 percent in January to 3.1 percent in October. However, core inflation indicators—which exclude “particularly volatile” items such as food and energy prices in order to “better reflect the underlying trend of inflation”—remain a bit higher, at 3.5 to 3.6 percent.

The BoC also noted that government spending and new home construction are boosting the economy and that wages are still rising by 4 to 5 percent.

“It is not good in the sense that we have an aging population, and when you have an aging population and the labour-constrained economy, you want productivity to go up and of course, GDP per capita. If it [GDP per capita] goes down, it’s the opposite of productivity improving,” Mr. Brassard said.

The BoC pointed to economic growth contracting at a rate of 1.1 percent in the third quarter and said consumption growth in the last two quarters was basically flat.

Mr. Brassard added that Canada may well be in a technical recession currently—two straight quarters of GDP contraction—given the big public sector strike in Quebec.

“Key determinants for improving productivity and growing GDP per capita will be whether businesses ramp up investment in response to the labour supply surge, how quickly newcomers integrate into the economy, and the extent to which higher-skilled migrant workers are favoured by immigration policy,” according to a Nov. 27 note from Oxford Economics.

The central bank said that business investment has been “essentially flat over the past year.”

Rate Cut Forecasts

The bar for lowering rates may be high, Mr. Brassard indicated. 

“I think they’re looking at below 3 percent for the core measures,” he said, adding that other considerations could be job growth stopping and possibly unemployment getting over 6 percent.

The unemployment rate at 5.8 percent in November has been gradually moving higher since April.

“They want to be 100 percent sure that they need to lower rates,” Mr. Brassard said. “They might be 100 percent late [to start cutting rates]. You know how it is when you want to be 100 percent sure of your decision—they might again come late.”

The C.D. Howe Institute’s monetary policy council said on Nov. 30 that the Bank of Canada should reduce its overnight rate target to 4.75 percent by next June and to 4 percent by December 2024.

TD is looking for the first rate cut in July, although the Bay Street bank said markets are pricing in the first cut for April. 

CIBC’s view is also that the first rate cut will come later than what market pricing indicates. Chief economist Avery Shenfeld said in a Dec. 6 note that CIBC sees the overnight rate target at 3.5 percent by the end of 2024.

Financial markets have rallied since the Bank of Canada’s previous interest rate decision in October on the hopes of rate cuts as inflation comes down and the potential to avoid a recession. 

As of the close on Dec. 6, the Toronto Stock Exchange index is up 7 percent since Oct. 25 and the Canadian dollar is up 1.5 percent. 

The Canadian 10-year bond yield has plunged about 80 basis points (0.8 percentage points), meaning bond prices have increased sharply.