Varun Kohli January 12, 2024 No Comments

The end of 2023 saw the Bank of Canada maintaining its benchmark interest rate in the last three decisions, prompting a significant shift in market discussions from potential rate hikes to the anticipation of rate cuts. Tembo is noting that this broad discourse is present not only in Canada, but across the media spectrum in the U.S. Analysts have been closely monitoring language from the Fed in anticipation that U.S. rates will fall. This is especially timely given the interest costs on U.S. Federal Debt now exceed $1 trillion a year – a huge squeeze on U.S. finances.

Even Tiff Macklem, the Bank of Canada’s top policymaker, has recently hinted at the possibility of rate cuts this year. Despite ongoing warnings about potential rate hikes if inflation control progress falters, there seems to be a growing acknowledgment that adjustments may be needed.

The Bank of Canada’s swift increase in the policy rate, currently standing at 5.0%, up by 4.75 percentage points since March 2022, has created substantial pressure on Canadian households, businesses, and governments. This surge aims to curb inflation, leading many Canadians, especially homeowners facing mortgage renewals, to keenly monitor signs of the tightening cycle possibly coming to an end.

Economists in discussions with Global News are forecasting a policy rate decline for 2024. However, similar to Macklem and his colleagues, they approach these predictions with caution. Experts suggest that the journey back to the central bank’s two percent inflation target might encounter obstacles, potentially delaying the timeline for interest rate cuts in the coming year.

Macklem, in a year-end speech at the Canadian Club in Toronto, commended the significant progress made in cooling inflation. He expressed satisfaction with the outcome of the second year of monetary policy tightening, asserting that the economy is no longer overheated, alleviating inflationary pressures.

As of November, the annual inflation rate is at 3.1%, a notable decrease from the 41-year high observed in June 2022. Expectations of inflation dropping below three percent in November were surpassed, with persistent price pressures noted in groceries, shelter, and some services.

After Macklem’s speech, he stated in an interview with BNN Bloomberg that the Bank of Canada anticipates interest rates coming down at some point in 2024. Emphasizing the necessity for sustained progress in core inflation metrics before committing to rate cuts, Macklem’s counterpart in the U.S., Jerome Powell, was more straightforward, announcing the expectation of three rate cuts in 2024.

Following the November inflation data, many economists on Bay Street reiterated their predictions for rate cuts. While some forecast cuts by June, money markets indicate cuts as early as April. However, Derek Holt, Vice-President and Head of Capital Markets Economics at Scotiabank, remains unconvinced, citing potential risks that point more towards another hike than a shift to cuts.

Housing market concerns and geopolitical tensions are shared by Holt and the Bank of Canada. The governing council’s meeting minutes on Dec. 6 expressed worries about easing monetary policy prematurely, potentially triggering a rebound in housing activity. Despite the concerns, some borrowing costs have already started decreasing, with five-year fixed rates on insured mortgages falling below five percent in December.

Holt argues for the Bank of Canada to maintain its tightening bias, expressing concern that signaling an end to hikes could fuel expectations of rate cuts. Relief on mortgage rates, coupled with constrained housing supply and increased demand after a year of robust job gains and population growth, may result in a heated spring market.

Apart from real estate, potential disruptions in the inflation outlook include geopolitical tensions in the Middle East. Concerns about supply chains and global inflation due to such escalations are reminiscent of the impact of the Russian war in Ukraine.

Looking at the global stage, Holt’s attention is on the 2024 U.S. election. He suggests that a second Donald Trump presidency could present challenges, with potential geopolitical risks to trade and supply chains. If these risks materialize, the Bank of Canada might face weaker growth and persistent inflationary pressure.

Wage growth remains a point of concern for Holt, with growth in the range of four to five percent considered excessively high in relation to inflation. The Bank of Canada has flagged these pay gains and productivity declines as inconsistent with the goal of bringing inflation back to target.

The Canadian labour market added jobs in 2023, despite a rise in the unemployment rate due to a growing workforce. Signs of cooling in the data are noted, and the trajectory of Canada’s overall economy holds sway over the central bank’s rate path.

Forecasts by Holt and Pedro Antunes, Chief Economist at the Conference Board of Canada, predict the Canadian economy avoiding an outright recession. Some forecasters anticipate a short, shallow recession for late 2023 or early 2024, but not with severe job losses. Antunes notes that if growth takes a more significant hit in the new year, the Bank of Canada may need to act swiftly.

Macklem’s year-end speech suggests that 2024 will be a “year of transition,” with difficult quarters ahead as growth slows, and consumers rein in spending. Despite the challenges, Macklem remains optimistic that the conditions for achieving the two percent inflation goal are increasingly falling into place.

Macklem predicts that by the year-end speech in 2024, the economy will be growing again, and inflation will trend back towards two percent. The Bank of Canada’s latest forecasts target annual inflation hitting that target sometime in mid-2025. However, Macklem acknowledges the difficulty of predicting the future and emphasizes the need for vigilance. Even modest rate cuts could have the capacity to supercharge the market and kickoff another bull run on prices. Let’s wait and see what happens, and if inflation will stay low.

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