Varun Kohli March 9, 2023 No Comments

The Bank of Canada finally decided to pause interest rate increases at its March 8th decision meeting. Markets did not anticipate a hike, and analysts who were hawkish believed a 25 basis point increase was as far as the BOC would go. The BOC’s decision is an acknowledgment of the positive progress that has been made to decrease inflation since the institution first raised rates in early 2022. There have been seven consecutive months of declining or stagnating inflation in Canada since June of 2022. Canada is in a good position relative to many of its partners, as there are economies that are continuing to wrestle with double digit inflation or rising inflationary pressures that have not been tamed. In contrast, Australia’s central bank just decided to raise rates for a tenth time, albeit to 3.6% vs. the 4.5% at home. Additional rate hikes in Australia are likely, as are more in the UK, the European central bank, and a few other jurisdictions.

In Canada, prices for a wide variety of goods, including food and fuel continue to either increase or remain stubbornly high. Milk, meat, egg, and gasoline prices are picking up or at unsustainable levels. The federal parliament held a committee hearing which saw the heads of Canada’s largest grocery companies held to account for why their firms have raised food prices so much. Grocery executives claimed that the main driver of their high profits was not inflation and price increases, but margins on medication and other goods. They argued that their margins were still low, and that they have resisted higher price pressures from suppliers while offering customers lower-cost brand options. The BOC has also touched upon this issue, saying that it will be forced to respond with higher rates if food prices don’t start to stabilize and fall within a reasonable amount of time. In truth policymakers are limited in how to stimulate a fall in prices. Fiscal policy is under pressure from deficits and high borrowing costs, tax cuts on gasoline would rob governments of revenue, and industry and suppliers are desperate for skilled labour. High immigration intake levels are in place and action on enhancing the skilled trades continues to build, but these efforts will take time to be felt by ordinary Canadians.

The truth is that there are deep structural imbalances within the Canadian economy that will take time to heal. These are issues which have been developing since well before the pandemic started, but which COVID aggravated. Skilled labour shortages in productive sectors have been a problem for decades, and are now reaching a crescendo. Supply chain dislocation and change continues. Trading partners around the world are facing similar obstacles. Countries are increasingly looking to secure their own supplies and talent at the expense of exports. The cost of capital has gone up. Large private, public, corporate, and household debts that have been built up over many decades are now expensive to service. Investors are increasingly cautious and uncertain of where to park their resources. Labour groups see this period as their chance to secure large gains for their workers in higher wages, greater security, and more benefits. The dynamic is complicated, multi-faceted, and deep. It is for these reasons that inflation, while declining healthily, is going to continue to pose structural problems. Despite the fact the BOC expects inflation to fall to 3% by mid-year if trends continue, we’d advise caution and preparedness for the unexpected. We’re not out of the woods yet, and that is a difficult truth but one that Tembo believes are clients and readers should be mindful of.

The good news is that despite the challenges of inflation and high prices, we’re at a point now where most surveilled economists believe rates will remain in place at 4.5% until the end of the year. The bigger problem that is emerging is the very real and pressing risk that the national economy will soon slide into recession. This would likely be good news for inflation, but would create a whole host of other obvious challenges. As Tembo has previously noted, GDP growth in Q4 of 2022 was 0% – economists had predicted a modest increase of 1.3%. The BOC has acknowledged this, and pointed to household consumption weakening as a driving cause (exactly what the BOC wants). Turning to the U.S., the latest data shows almost 80,000 layoffs announced across the economy in February 2023, a number not seen since January 2009 and the global financial crisis. 180,000 layoffs have been announced in the United States since the start of the year, a concerning number which fuels the recession narrative that is building. Another element of concern is that many high-level layoffs have been announced in sectors that have long been engines of growth (tech and big data). Jobless claims are surging in California and New York, key economic powerhouses.

At home, employment numbers that have been recently released have been extremely promising, despite growth slowing. Nevertheless, trends in the U.S. are critical for the Canadian economy and Tembo keeps a close eye on them. It will be interesting to see if layoffs continue to be reported in the U.S., and if they start to appear in Canada. The structural disparity of serious skilled labour shortages in many productive and goods producing sectors and layoffs in others is an interesting dynamic in today’s economy. Tembo will continue to inform its readers and clients of economic and financial trends and how they will impact rates and the real estate market.

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