Bank of Canada policymakers have different opinions on when there will be enough proof that the right conditions are in place to lower interest rates, but they all agree it should happen sometime this year. This comes from a summary of discussions that led to a decision to keep the key overnight rate at five per cent on March 6.
“Members agreed that if the economy evolves as the bank expects, the conditions for rate cuts should happen this year,” as per the summary released on March 20. “However, there was some diversity of opinions among governing council members about when there would likely be enough evidence that these conditions were in place, and how to evaluate the risks to the outlook.”
The discussions revealed a potential risk to the inflation outlook: the housing market.
“While house prices continued to fall in January, recent strength in resales could lead to an increase in house prices, raising shelter price inflation,” a potential outcome they discussed, according to the summary.
However, Bank of Canada governor Tiff Macklem and the five other governing council members concluded that they cannot ignore the impact of past interest rate increases on mortgage costs, which is driving shelter price inflation. This will disappoint some market watchers predicting an early rate cut.
“Members agreed that if mortgage interest costs were the only factor influencing inflation, there could be some leeway to overlook them, so as not to excessively restrict economic activity in order to bring headline inflation back to (the central bank’s target of) two per cent,” the summary stated. “However, this was not the current situation. Most factors of shelter inflation, such as rent and expenses related to homeownership (including insurance, taxes and repairs), were still increasing significantly in January.”
Governing council members also noted that Canada’s mortgage renewal cycle means higher mortgage interest costs will have a “persistent, but not permanent” effect on CPI (consumer price index) inflation.
The central bankers acknowledged that shelter price inflation, which includes mortgage interest costs, rent and components related to home ownership, remained high at 6.2 per cent in January, and continued to be the biggest contributor to total CPI inflation. They also agreed that recent housing market indicators suggest this is likely to persist, which would mean that high shelter costs will continue to be an important contributor to CPI inflation.
Yet, they concluded that “recent data had made it clear that inflationary pressures were still broad-based, and underlying inflation had yet to show sustained downward momentum.”
The policymakers also agreed they would need to see further and sustained easing of underlying inflation before cutting rates. Their focus will be on core inflation as well as several key indicators, including corporate pricing behavior, inflation expectations, wage growth relative to productivity and the equilibrium of supply and demand in the economy.
The information they were working with in March showed slow progress in reducing inflation to the target of two per cent. The proportion of items in the CPI basket growing at over three per cent continued to decrease, but was still close to 45 per cent and remained significantly higher than the historical average.
The central bank’s preferred indicators of core inflation that remove unstable measures were both lower, at 3.4 per cent for CPI-trim and 3.3 per cent for CPI-median. However, both were still above three per cent when measured over 12-, six-, and three-month periods.
“Governing council members saw nothing in the data that would alter their view that CPI inflation will stay around three per cent in the upcoming months,” according to the summary of discussions.
Since the March 6 rate-setting announcement, when the key overnight interest rate was kept at five per cent for the fifth consecutive time, data shows inflation has decreased while home prices have slightly increased.
Headline CPI inflation surprised by dropping to 2.8 per cent in February, with slowing food inflation among the reasons. The Bank of Canada’s preferred measure of “core” inflation, on the other hand, decreased in February to 3.2 per cent year over year, compared to 3.4 per cent in January.
Economists at Toronto-Dominion Bank said it was the first time since 2021 that grocery inflation was below headline inflation. Year-over-year grocery prices increased by just 2.4 per cent in February compared to a 3.4 per cent rise in January.
However, economic indicators continue to be uneven, with shelter inflation still increasing. Rent inflation increased to 8.2 per cent year over year, while the overall cost of owned accommodation was up 6.7 per cent, according to the TD report.
Housing prices in Canada’s 11 largest census metropolitan areas rose by 0.2 per cent in February on a seasonally adjusted basis, the first increase after four consecutive monthly decreases, according to the Teranet-National Bank Composite House Price Index, which was released March 19.
TD economists are predicting the overnight interest rate will remain unchanged until July.
“We expect that inflation will have cooled enough by July for them to loosen up with a first interest rate cut,” they said in a note.
Andrew DiCapua, senior economist at the Canadian Chamber of Commerce’s business data lab, is also expecting the Bank of Canada to continue holding rates through June, while taking the time to digest two more inflation updates, updated surveys on expectations and a federal budget.
But some market watchers are predicting a June rate cut.
- Bank of Canada going to have to cut rates sooner than Fed
- Rate cut watchers starting to look past summer
- Canada’s inflation rate slows more than expected
Dominique Lapointe, director of macro strategy at Manulife Investment Management Ltd., said there appears to be a growing emphasis on CPI measures that exclude mortgage interest costs, the largest contributor to inflation, reinforcing a dovish tilt at the Bank of Canada as inflation cools.
The speaker stated that with almost no growth in the economy since the second half of 2023, they expect the BoC to prepare for a rate cut in June at its April 10 monetary policy report.
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