And still it grows

The Canadian economy continues to defy predictions of recession. Statistics Canada reported this morning that real GDP grew 0.1 percent in October, beating its preliminary estimate that growth would be flat. September GDP, initially reported as a 0.1 percent gain, was revised up to 0.2 percent. StatsCan's preliminary estimate for November calls for another 0.l percent gain, so it looks all but certain that GDP for Q4 as a whole will be in positive territory. 

October's growth was entirely accounted for by the services sector, which posted a 0.3 percent gain, led by the public sector and what StatsCan refers to as "client-facing industries.  By contrast, goods producing sectors were almost uniformly weak, with an overall 0.7 percent decline led by falls in resource extraction, utilities and manufacturing. For the manufacturing sector this marked the fourth decline in the last six months.

It is hard to see data such as today's having much impact on the Bank of Canada's rate decision in January. Eking out monthly growth at a 0.1 percent pace seems to be the very definition of the soft landing that the Bank is hoping to achieve. With the full impact of past tightening still to be felt, there is every possibility that the economy will be flat, at best, in early 2023. Thus the path of rates will depend entirely on whether the Bank is satisfied that the rate of inflation really is headed back towards its 2 percent target. 

UPDATE: Also released today without much fanfare, the Department of Finance reported that the Federal government posted a C$ 1.9 billion deficit in October. This means that after seven months of the current fiscal year, the budget has a cumulative deficit of less than C$ 0.2 billion. For comparison, the deficit for the same period of the previous fiscal year was C$ 72.3 billion. 

Merry Christmas!

Many thanks to everyone who has taken the time to read this blog during the past year. I wish everyone a Merry Christmas, and hope that 2023 will be a better year than the last three have been!

Canada CPI: year-on-year numbers continue to mislead

OK, so here's the headline number that the media are focusing on: Canada's year-on-year consumer price index rose 6.8 percent in November, compared to a 6.9 percent rise in October. Market expectations had been for a 6.7 percent print, so the data mean the Bank of Canada has more to do on the tightening front.

And here's a better way of looking at it: Canada's CPI rose 0.1 percent month-on-month in November. That's identical to the rise seen in September, and suggests that the gasoline-propelled 0.7 percent monthly increase in October was an anomaly. Even if we include that October number, the annualized rate of increase in headline CPI for the past three months comes in below 4 percent. This suggests that Bank of Canada tightening is already having a significant effect, so no further tightening is likely to be needed. 

Looking beyond the headlines, we find that a major contributor to the lower monthly print in November  was a 3.6 percent fall in gasoline prices, partially reversing the 9.2 percent spike seen in October. Even with the latest decline, gasoline prices remain 13.7 percent higher than a year ago. December has seen further weakness in prices at the pumps, suggesting that this factor will exert a downward bias on overall CPI for the month.

Food price trends are less reassuring. Prices for food purchased from stores (i.e. as opposed to restaurant meals) jumped 1.2 percent in the month, pushing the year-on-year rise to 11.4 percent, up from 11.0 percent in October. There is also upward pressure on shelter costs: mortgage interest costs were 14.5 percent higher in November than a year ago, indicating that Bank of Canada rate hikes are directly increasing the very inflation they are intended to reduce. 

So-called special aggregates are generally showing slower inflation than the headline numbers. Ex-food CPI actually fell 0.1 percent in November, for a year-on-year increase of 6.2 percent. The index ex food and energy rose just 0.1 percent in the month, for a year-on-year increase of 5.4 percent. And we mustn't forget the Bank of Canada's preferred core inflation measures, much as the Bank might wish that we would. These measures are showing little sign of easing; two of the three moved higher in the month, and the mean reading now stands at 5.7 percent. 

It remains a mystery that the Bank of Canada, like the Fed, makes little or no effort to push the message that the running rate of inflation is well below the year-on-year rate. Instead, it allows the media to focus on the seemingly glacial pace of reduction in year-on-year CPI. Perhaps the Bank is reluctant to declare victory too soon, in case some unexpected development comes along and pushes prices back up again. What is certain is that the November data either completely justify another rate hike in early 2023, or mean that rates have already peaked, depending entirely on how you choose to read the numbers. 

The data and the decision

The US consumer price data that were released on Tuesday provided an interesting lead-in to the Fed's latest rate decision. The BLS data showed that headline CPI rose 0.1 percent in November (vs. expected 0.3 percent), dropping the year-on-year rate to 7.1 percent (vs. expected 7.3 percent). The headline number was heavily influenced by a further 2 percent fall in energy costs, but given that energy costs accounted for so much of the inflation spike earlier in the year, this is not surprising.  

Food prices continue to rise, albeit at a lesser pace than a few months ago: the 0.5 percent increase seen in November means that overall food prices stand 10.5 percent higher than a year ago.  Excluding energy and food, CPI rose 0.2 percent in the month, meaning that this measure of core inflation rose 6.0 percent from November 2021.

While acknowledging the evidence that inflationary pressures seem to be on the wane, media reports on the data continue to focus on the year-on-year figures. This approach is becoming less logical with each passing month. A glance at the top line of the data table in the BLS release shows that month-on-month headline CPI increases since July have averaged just 0.2 percent, which means that on an annualized basis, headline CPI has been not far above the Fed's 2 percent goal for almost half a year.  

Given the recent CPI data, then, the key question going into the FOMC announcement was this: would the Fed continue to fret about the elevated the year-on-year inflation numbers, which largely reflect price developments many months ago that the Fed obviously cannot do anything about, or would it unequivocally switch its focus to the emerging story of much lower inflation?  The answer, it turns out, is continued fretting. 

Although the hike in the Fed funds target this time was 50 basis points rather than the 75 bp that we have become accustomed to, much of the rhetoric in the press release indicates that the Fed still thinks it has more work to do. "Inflation remains elevated", which it does, but only if you look at the year-on-year data rather than the more recent monthly prints. "The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time", a view that appears to ignore the fact that the running rate of inflation over the past five months is already not far above that 2 percent target. 

There is no real sign of any real pivot in the Fed's policy approach there. It need hardly be said that this is not the kind of release that equity markets were expecting after the CPI data were published, so it is no surprise that stocks sold off after the announcement. The "dot plot" in the newly-released Summary of Economic Projections shows that an overwhelming majority of the FOMC expects the funds target to top 5 percent in 2023, which implies there is at least one more 50 bp rate hike to come. One FOMC member expects a rate target above 5 percent to continue right into 2025.

Those of us who complained that the Fed waited far too long to start the tightening cycle were vindicated by the spike in inflation that persisted into the first half of this year. It seems more than likely that the Fed is making an equally serious error now, in continuing to tighten when there is plenty of evidence that the inflation battle is already won. 

Are we there yet?

Ahead of today's Bank of Canada rate announcement, there had been some speculation that the Bank might signal an imminent policy "pivot" with a rate hike of only 25 basis points. In the event the Bank opted for a 50 basis point move, bringing its target rate to 4.25 percent.  

The tone of the media release is very assertive, as the Bank tries to beat back criticism that its tightening may already have gone too far. This is particularly true of the paragraph on inflation, quoted hare in full:

CPI inflation remained at 6.9% in October, with many of the goods and services Canadians regularly buy showing large price increases. Measures of core inflation remain around 5%. Three-month rates of change in core inflation have come down, an early indicator that price pressures may be losing momentum. However, inflation is still too high and short-term inflation expectations remain elevated. The longer that consumers and businesses expect inflation to be above the target, the greater the risk that elevated inflation becomes entrenched.

Not much hint of a pivot there, but other parts of the release strike s slightly softer tone: 

...there is growing evidence that tighter monetary policy is restraining domestic demand: consumption moderated in the third quarter, and housing market activity continues to decline. Overall, the data since the October MPR support the Bank’s outlook that growth will essentially stall through the end of this year and the first half of next year.

The final paragraph of the release, while reaffirming the Bank's commitment to restoring CPI to the 2 percent target, opens with a strong hint that the Bank may now pause for a while to assess whether it has tightened policy sufficiently: 

Looking ahead, Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target. 

Surely not by coincidence, the economics folks at Scotiabank this week released a provocative report arguing that pandemic support programs (i.e. fiscal policy) account for the situation of excess demand that the Bank of Canada is trying to suppress. This statement from the report could hardly be more damning:

Pandemic support programs for firms and households are creating the excess demand that the country is experiencing. Absent from these support measures, Canada would still be in excess supply....

In other words, the Bank of Canada’s policy rate would not need to be above neutral were it not for these programs.

Indeed so. Monetary and fiscal policy working at cross purposes never ends well. The Bank must have been frustrated to see the Government's recent Fall Fiscal Statement, which loudly trumpeted restraint while spending most of the unexpected revenue boost that has accrued this fiscal year. That will not make the Bank's job any easier, but it still seems likely that there will be at least a pause in monetary tightening as we enter 2023.  

November jobs data: little comfort for policymakers

Employment data for the US and Canada for November, released in both capitals this morning, offer little reason to expect an early pivot in monetary policy, give that both the Federal Reserve and the Bank of Canada seem to be taking a Phillips-Curve-based approach to rate setting. 

In the US, the Bureau of Labor Statistics reported that non-farm payrolls rose by 263,000 in November, leaving the unemployment rate unchanged at 3.7 percent.  The number of jobs was above market expectations,  but after taking into account revisions to the two preceding months (downward for September; upward for October), it represented the slowest pace of job growth since April 2021. It is also well below the average gain of 392,000 per month seen so far in 2022.  Less positively, at least from an FOMC perspective, wages rose 0.6 percent in the month, bringing the year-on-year gain to 5.1 percent. This is still well below the rate of inflation, but does not give any evidence that the hoped-for Phillipsian trade-off is starting to occur.   

Taken at face value, today's data would seem to present a case for another aggressive rate hike by the Fed at its December 13-14. However, Fed Chair Jay Powell has hinted broadly at the possibility of a less aggressive move this month. Recall also that the last FOMC statement suggested that the committee would be cognizant of the lagged effect of past rate moves in setting future policy.  A 50 basis point move seems the likeliest outcome, but another 75 bp hike would not be a big surprise. 

In Canada, the headline number does not look quite as robust: employment rose just 10,000 in November, well below the outsized gain of 108,000 posted in October. However, some of the details suggest that the overall labour market remains healthy. The unemployment rate ticked down to 5.1 percent; full-time employment rose by 51,000 positions; and year-on-year hourly wages rose 5.6 percent. This is the sixth straight month of wage gains in excess of 5 percent, though this figure remains well below the annual pace of inflation. 

These figures suggest the Bank of Canada's rate decision next week will be a little less difficult than the Fed's. Although the job market is tight, employment gains in recent months have been relatively modest, aside from the anomalous strength in October. However, the historically low unemployment rate and the steady rise in wages both warrant caution, until it becomes clear that past rate hikes are having the desired effect. As in the US, a 50 bp rate hike seems likely this month. 

That damned, elusive recession

They seek it here, they seek it there, the media seek recession everywhere. On Tuesday Statistics Canada reported that Canada's real GDP rose 0.7 percent (or 2.9 percent annualized) in the third quarter of the year, almost twice the expected pace. So what did the media report? well, the headline on this story from the CBC website is fairly typical: "Canada's economy is still growing but signs of slowdown are everywhere".  

The media have been saying more or less the same thing since at least May and they have been mostly wrong. Are they right this time? Well, maybe. The StatsCan report shows that the biggest source of growth in the quarter was the export sector, which posted a 2.1 percent real terms gain, led by crude oil, bitumen (i.e. tar sands products) and agricultural/fisheries products. Several indicators of the domestic economy paint a noticeably softer picture: inventory accumulation provided a strong boost to overall growth for the second consecutive quarter, which is likely unsustainable, while housing investment fell for a second straight quarter, obviously in response to Bank of Canada rate hikes

Perhaps most significant of all,  household spending edged down by 0.3 percent in the quarter, its first decline since Q2/2021. This may in part reflect slowing growth in employee compensation, which rose at the slowest pace since Q2/2020,  the worst point of the COVID pandemic. In addition, the household savings rate rose in the quarter to 5.7 percent, which is more than twice as high as was seen in the same quarter of 2019 (i.e. before the pandemic). This suggests the belt-tightening the Bank of Canada wants to see is beginning to occur, though household savings are still much too low to protect the majority of households against the effects of the Bank's policies.  

As usual, StatsCan also reported the latest monthly GDP data alongside the quarterly figures. Real GDP edged up by 0.1 percent in September, led by the goods-producing sectors (other than manufacturing). Preliminary data suggest that GDP was unchanged in October, though these preliminary estimates have been subject to considerable revision in the recent past. We can perhaps reasonably assume that real GDP will be little changed for Q4.  Let's suppose GDP then starts to fall -- though that is, of course far from certain.. Given that the media's favoured definition of a recession is two straight quarters of declining GDP, that would mean it would not be possible to call a recession until the Q2/2023 GDP data appear -- at the end of next August! By that time the media's initial recession call will be well over a year old. Nice job, guys and girls. 

In case you missed it...

For some reason the turnaround in the Canadian Federal Government's finances continues to be ignored by the media. This is, of course, allowing the Conservatives, particularly their noisy new leader Pierre Poilievre, free rein to spout endless untruths about the dire state of the national fisc.  Poilievre is probably right to say that the COVID measures were initially overdone and then removed too slowly, but that does not alter the fact that the situation has now changed dramatically. 

The Department of Finance reported this past week that the Federal budget recorded a deficit of C$ 2,2 billion in September 2022, down from a shortfall of C$ 11.4 billion in the same month last year. For the 2022/23 fiscal year to date (i.e. April-September), the budget has seen a surplus of C$ 1.7 billion, compared to a deficit of C$ 68.6 billion in the same period of fiscal 2021/22.  Revenues are up across the board, while spending is sharply lower as a result of the expiry of COVID-related programs. One small blot on the overall picture is the rise in public debt charges, as Bank of Canada tightening translated into higher financing costs as maturing debt is rolled over. 

The Government's Fall Economic Statement at the start of November projected a deficit for the full fiscal year of C$ 36.4 billion -- and here we are, halfway into the fiscal year, with the budget still in cumulative surplus. There are at least three reasons to expect the budgetary position to worsen in the next few months: the regular seasonal pattern in Federal budgets always sees worse results in the second half of the fiscal year; the new spending measures announced in the Fall Statement will start to kick in; and the much-anticipated recession may finally materialize. Still, it already seems likely that the final outcome will be a significantly lower deficit than the Finance Minister projected less than a month ago.

Canada CPI: not bad, but not good

With gasoline prices heading back up again, the consensus expectation for Canada's October CPI foresaw a slightly higher year-on-year rate. As it turned out, Statistics Canada reported this morning that headline CPI rose 6.9 percent from a year earlier, the same pace as in September. Month-on-month the rise in CPI was 0.7 percent, up from only 0.1 percent in September, but this was almost entirely due to a big jump in gasoline prices. It still seems likely that the peak of the inflation spike has passed, but improvement in the year-on-year rate is likely to be slow.

Gasoline and food prices continue to be the principal drivers of headline CPI, both statistically and in the eyes of the public. Gas prices jumped 9.2 percent in October, pushing the year-on-year change, which had been falling in recent months, back up to 17.8 percent. However, there are some signs of moderation in food prices, which rose only 0.4 percent on a seasonally adjusted monthly basis in October, down from 1.2 percent in September; this still leaves food prices 10.1 percent higher than a year ago.

Stripping out food and energy prices, core CPI edged down to a 5.3 percent gain in October from 5.4 percent in September. Two of the Bank of Canada's three preferred inflation measures ticked higher in the month. The mean value of these measures remains just above 5 percent.  Average hourly wages, which the Bank of Canada is undoubtedly watching nervously, rose 5.6 percent in the year to October, up from 5.2 percent in September. 

What happens next? Gasoline prices have been much better behaved in November than they were last month, so it seems likely that the strong month-on-month gain in headline CPI seen in October will not be repeated this month.  However, even if monthly gains return to a slower track, it will still take some time for the closely-followed year-on-year number to fall significantly, since the outsized monthly gains seen last winter are still biasing the calculation higher. The Bank of Canada is approaching the end of the current tightening cycle, but a further 50 basis point increase in the target rate is likely in December. 

Pete's brag sheet

Many years ago I worked in a Bay Street dealing room with Peter Bethlenfalvy, who is now Ontario's Finance Minister. Once or twice a years, he and I and the rest of our colleagues used to compile what we called a "brag sheet": a list of all the ways we'd made money for the firm, designed to maximize our share of the bonus pool.  

I have no need for a brag sheet any more, but Peter B. still seems to have the appetite for it. His Fall Fiscal Statement, release on Monday, is a veritable paean to all the things the Doug Ford government is doing to advance the Provincial economy. The headline of the press release is typical brag sheet stuff: "Ontario Delivers Progress Report and Advances its Plan to Build". Many of the "targeted measures" listed in the release are previously announced items, such as some ill-advised roadbuilding schemes, while others have the status of "proposals".  

There is also a highly braggadocious "building Ontario progress report" that lists a wide variety of mostly off-budget items for which the Province seeks to take credit. These include commitments by automakers to invest in battery development in Ontario, a "critical minerals strategy" to attract investment, and the hiring of 11,700 health care workers. Media interviews with Peter B. after the update was tabled strongly suggest  that he -- and, no doubt, Premier Ford -- resent the fact that they get little recognition for this last item. 

The only significant sort-of-new measure that most Ontarians will notice is an extension of the Government's gasoline tax rebate; set to expire at the end of this year, it will now remain in place through 2023. Premier Ford evidently thought this was such a red hot idea that he stole Peter B.'s thunder, pitching up at his local gas station in Etobicoke on Sunday morning to make the announcement. 

Something Peter B. can't brag about too much is the bottom line. It is likely that nobody was more amazed than Peter when the Province recorded a C$ 2 billion surplus for fiscal 2021/22, which ended in early April, compared to a C$ 20 billion-plus deficit originally expected.  No surplus this year: the update projects a deficit for FY 2022/23 of C$ 12.9 billion, though it should be noted that this is well below the C$ 19 billion projected back in the Spring budget. 

Like the recent Federal fiscal update, the Ontario update offers differing courses for the deficit beyond this year.  However, in both the slower and faster growth scenarios, the deficit is forecast to be on a steady downward path, with a return to surplus in FY 2024/25 or at latest 2025/26. The Province's own fiscal watchdog, in its most recent update, was even more optimistic about the timing and sustainability of a return to balance. 

Unless things go drastically wrong -- and recent history suggests they usually do -- the budget should at worst be close to balance by the time of the next Provincial election.  Given Ontario's dubious distinction as the most indebted non-sovereign jurisdiction in the world, this would represent something of an accomplishment. 

That darn Phillips curve again

Bank of Canada Governor Tiff Macklem delivered a speech in Toronto today that attempts to set out the Bank's  rationale for tightening policy even as fears of recession mount. There's nothing particularly new, but the speech does make a few things more explicit than they have been up till now.  Unfortunately, that turns out not to be particularly reassuring.

When the economy is operating above maximum sustainable employment, businesses can’t find enough workers to keep up with demand. As a result, prices go up and inflation rises. That’s where we are today.

No, it isn't. The Governor seems to be saying that current inflation is the result of excessively tight labour markets forcing up wages and thereby compelling companies to raise prices -- in other words, a wage-price spiral. That's not what's happening at all. Inflation is largely the result of pandemic-related supply shocks, exacerbated by the impact of the Russian invasion of Ukraine.  Wage gains have been creeping up but remain well below the rate of inflation, rather than pushing it higher.

One thing that Macklem's statement does make clear is that the Bank is fully onboard with the so-called Phillips curve, which nowadays is generally taken to imply there is a direct tradeoff between tight labour markets and inflation. There's one problem with this, even if we are not bothered by the fact that Phillips's paper was written more than sixty years ago. That paper showed a statistical relationship between the unemployment rate and wages, not inflation. It might be reasonable to assume that high wage gains can be curbed by tightening policy and boosting unemployment, but when you have inflation that is almost entirely unrelated to wage gains -- today's situation -- it becomes much harder to see the logic of trying to curb inflation that way. 

Demand is what the Bank influences with interest rate increases. Our analysis suggests that because the labour market is hot and we have a high number of vacant jobs, we can afford to cool the economy without causing the surge in unemployment that we experienced in previous recessions.

Wait, what?  The whole logic of the Bank's recent policy moves surely relies on the Phillips-y idea that cooling the economy from its current condition of excess demand will bring down inflation, in large measure by cooling wage demands. But Macklem seems to be saying that this can be achieved without significantly boosting the unemployment rate. It's not remotely clear how that's supposed to happen. 

Is there anything in the speech that helps us understand what the Bank's next moves might be? Well, there's this: That’s why we have front-loaded our interest rate increases.

At the risk of over-parsing, the use of the past tense "have front loaded" rather than "are front-loading" might be the merest of hints that the Bank is finished with outsized rate hikes and will proceed more cautiously from now on. Given the apparent flimsiness of the Bank's underlying assumptions, however, it's hard to be certain about that. 

Canada's Fall Economic Statement

Canada's Federal Finance Minister (and putative PM in waiting) Chrystia Freeland has spoken regularly about her commitment to fiscal responsibility. The Fall Economic Statement, released on Thursday, offered her a chance to put those words into practice. In the event, though far from irresponsible, it did not quite measure up. 

The Federal Government has been expressing concern over the rising risk of a recession in 2023, and of course the media are (wrongly) convinced a recession has already begun. Rather than keeping its fiscal powder dry to deal with that recession if, as and when it happens, the Government has chosen to introduce a raft of new spending measures right away -- and these are not one-off measures. You can find a list here. The measures are targeted and individually modest in size, but nevertheless add up to new spending amounting to C$ 30 billion over the next five years. Tory Leader Pierre Poilievre is unimpressed and it is reasonable to assume that the Bank of Canada, which is trying hard to slow the economy down, is not best pleased either.

Rather than focusing on the individual spending measures, it is more useful to look at how the Government's economic and fiscal projections have evolved since the budget was tabled back in the Spring. This annex to the official release has all the data one could possibly want, and it leads to some surprising conclusions. 

At budget time, the deficit for the 2022/23 fiscal year (roughly April-March) was forecast at C$ 52 billion. Data for the first five months of the fiscal year, released last week, showed the actual outcome was in fact a small surplus. In the absence of any new policy measures, Thursday's document states that the deficit for the full year would now be projected at C$ 23 billion, but -- and it's a big but -- the actual projection is C$36.4 billion! In addition to C$ 6.1 billion announced yesterday (part of that C$ 30 billion over five years referred to above), the statement casually slips in the fact that policy actions  announced since the budget (but before this week) amount to a further C$ 7.3 billion.  In effect, the Government intends to spend C$ 13 billion more than it announced just six months ago; to put it another way, it intends to spend almost half of the windfall represented by the difference between the initially projected deficit and the updated version. It is hard to see this as restraint.  

An interesting twist in this statement is the publication of a detailed "downside scenario" for the economy and the budget, designed to show what might happen if the slowdown in the economy in 2023 is worse than suggested.  For FY 2022/23 -- which, recall, is already half over -- the projected deficit balloons from the baseline C$ 36.4 billion to a startling C$ 49.1 billion.  With so little of the fiscal year left and the economy conspicuously not yet in recession (see: October employment data), this seems highly unlikely, especially as the Government is continuing to benefit hugely from high energy prices, which show no sign of going away any time soon.  

The deficit projections in the downside scenario remain above the base case throughout the customary five-year planning cycle, although they do fall gradually from a 2023/24 peak in excess of C$ 50 billion. Meantime in the base case, the deficit peaks in the current fiscal year and fall steadily thereafter, leading to -- wait for it -- a surplus of C$ 4.5 billion in FY 2027-28. This is the first time that the Trudeau Government, elected in 2015 on a promise to run small deficits for just a few years, has actually projected a surplus. It would be unwise to take it to the bank. 

The jobs keep coming

Employment data for October were released in both Canada and the United States this morning. Despite some uncertainty in the details, the new numbers give little cause for hope that monetary policy tightening will soon be at an end. 

In Canada, employment had been flat to slightly lower each month since May. That pattern of stagnation ended abruptly in October, with Statistics Canada reporting that the economy added 108,000 jobs in the month, versus the reliably risible analysts' expectation of just 10,000. A rise in the participation rate meant that the unemployment rate held steady at 5.2 percent, modestly above the record low 4.9 percent posted in June and July. 

Details of the report were uniformly strong. All of the new jobs created in the month were full-time; the new jobs were spread across the country, with six Provinces posting higher employment and the rest little changed; construction, manufacturing and accommodation were among the sectors posting gains, with retail trade the only significant laggard; and the private sector posted a solid gain of almost 75,000 jobs in the month after several months of small job losses. Year-on-year, both private and public sector employment are up by about 3 percent. 

One aspect of the report that will be of concern to policymakers is the rise in wages. Hourly wages accelerated to a 5.6 percent gain in October from 5.2 percent in September.  Given the widely-reported tightness in the jobs market, this is hardly surprising, and the gain remains more than a full percentage point below headline CPI.  However, even if we are far from the dreaded "wage-price spiral", the Bank of Canada will be watching the trend in wages with some trepidation. 

As for the United States, today's report from the BLS shows that non-farm payrolls rose 261,000 in October -- above market expectations for a rise of 200,000 but lower than the 315,000 jobs added in September. The unemployment rate edged up two ticks to 3.7 percent. So far this year, the average monthly gain in employment has been 404,000, so there is at least some sign that the jobs market may be starting to react to the Fed's policy actions, but from any longer-term perspective the monthly numbers are still strong and the market is indisputably tight. 

On the wage front, the news in the US is perhaps a little more encouraging for policymakers. Average hourly earnings rose 4.7 percent in the year to October, compared to 5.0 percent in September -- both figures are, needless to say, far below the increase in CPI.  It is beyond dispute that wages have almost nothing to do with the inflationary pressures in the US, so the Phillips-curve-based policy approach of combatting inflation by raising interest rates seems unlikely to be effective. That may not be enough to deter the Fed from remaining on its recent course. 

Another 75 from the Fed

It's getting to the point where these blog posts about FOMC decisions can be done on a cut-and-paste basis. As expected, the Federal Reserve today imposed its third fourth straight 75 basis point increase in the funds target range, which now stands at 3.0 - 3.25 3.75-4.0 percent. The press release signals there are more rate hikes to come, and also commits the Fed to continuing its policy of quantitative tightening. 

As was the case after the last two rate hikes, the press release's discussion of the economic background to its decision is skimpy. although Chair Jerome Powell's opening statement at his post-FOMC press conference was considerably more expansive and detailed.  Apart from a short paragraph on the impact of Russia's depredations in Ukraine, this is the press release's entire text on the economy:

Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.

Once again, the release offers little indication that the Fed yet sees any signs that its tightening policies are having the desired effect on either the real economy or inflation. Nor is there any mention of inflation expectations, even though keeping these in check is surely the main goal of this series of sharp rate hikes, since there is not much monetary policy can realistically do about the underlying causes of the recent inflation spike. 

The press release states that the FOMC anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. It goes on to add the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. That sentence, together with the customary statement that the Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals, has initially been interpreted by financial markets as a hint, however faint, at the possibility of a "pivot". 

It is something of a surprise that the Fed is not making any attempt to convince markets that its policy approach is working. Headline CPI is still way above target on a year-on-year basis, but by definition half of the data points that make up that number are more than half-a-year old. The latest monthly prints have been much lower than those seen at the start of the year. While that owes much to the fall in gasoline prices, it does appear that the peak in inflation has passed, even if the year-on-year rate will only reflect that fact as the next few months unfold.  

Are there more "supersized" rate increases to come?  Asked about this at the press conference, Powell did not rule it out, although he suggested that the question of moving to a more moderate pace of tightening would likely be on the agenda at the next FOMC meeting. The funds rate is now closing in in the most recent (i.e. September) 'dot plot" percent projection of a 4.6 percent rate in 2023.  It seems likely that the pace of tightening will slow soon, but there is every indication that FOMC believes that it will take a prolonged period of high rates to get inflation back to the target.  

Canada Federal budget still in surplus

Canada's Department of Finance today released its Fiscal Monitor for August. The month saw a deficit of C$ 2.5 billion, markedly lower than the C$ 9.8 billion shortfall recorded in the same month last year. For the first five months of the current fiscal year (i.e. April-August), the budget shows a surplus of C$ 3.9 billion, compared to a deficit of C$ 57 billion (!) last year. Although it is highly unlikely that there will be a surplus for the full financial year, it need hardly be said that these results are massively better than the Government was projecting, as revenues rise and COVID-related spending falls off the books. 

The Department of Finance also announced today that Finance Minister Chrystia Freeland will table the usual Fall Financial Update (aka mini-budget) on November 3. It is likely that the Government will take advantage of the improved fiscal position to announce at least a few targeted spending measures, but there are unlikely to be any significant giveaways.  Of course, none of this is likely to deter Tory leader Pierre Poilievre from blaming high inflation on "Justin Trudeau's deficits", but maybe the media will take notice. We live in hope.   

Soft landings still on track, barely

US GDP shrank marginally in the first two quarters of this year, meeting a commonly-accepted definition of a recession. However it seems unlikely that the NBER, which is the official arbiter of such things, will choose to use that term, firstly because the decline was so small, and secondly because the US economy returned to growth in the third quarter. The Bureau of Economic Analysis reported yesterday that real GDP grew at a 2.6 percent annualized rate in Q3, marginally ahead of expectations. Given that the growth was heavily reliant on the export sector, its sustainability may be questionable, but for now the Fed's goal of achieving a soft landing remains just about on track. 

Meanwhile here in Canada, the economy continues to inch ahead. Statistics Canada reported today that real GDP rose 0.1 percent in August, led by the service sector, with retail trade notably strong. The preliminary estimate for September suggests another 0.1 percent gain. If this is confirmed in the final data next month, it would mean that real GDP grew at a 1.6 percent annualized rate in Q3. That is only half the pace seen in Q2, but it is till a far cry from the recession that the media have been loudly proclaiming since at least May. 

That recession may still come, of course. The slow pace of growth indicates that both the Bank of Canada and the Fed have very little margin of error in setting policy if they really do which to achieve a soft landing. The Bank of Canada's smaller-than-expected rate move this week may be a sign that the recognize this; we will find out early next month whether the Fed is ready to be equally cautious.  

Bank of Canada: not ready to pivot just yet

The Bank of Canada duly delivered a further rate increase this morning, but in the form of a 50 basis point move rather than the 75 bp that markets were expecting. The overnight rate target now stands at 3.75 percent. The smaller move may be taken as a hint that the Bank thinks it is nearing the end of its tightening cycle, but it is clear from the press release and the updated Monetary Policy Report that it still expects to tighten further.  

The text of the press release is somewhat longer than usual and is largely the same as the Overview section of the MPR. Here are a few highlights: 

On global inflation: Inflation around the world remains high and broadly based. This reflects the strength of the global recovery from the pandemic, a series of global supply disruptions, and elevated commodity prices, particularly for energy, which have been pushed up by Russia’s attack on Ukraine...... As economies slow and supply disruptions ease, global inflation is expected to come down.

On global growth: The Bank projects no growth in the US economy through most of next year. In the euro area, the economy is forecast to contract in the quarters ahead, largely due to acute energy shortages...... Overall, the Bank projects that global growth will slow from 3% in 2022 to about 1½% in 2023......This is a slower pace of growth than was projected in the Bank’s July Monetary Policy Report (MPR).

On Canadian growth: In Canada, the economy continues to operate in excess demand and labour markets remain tight. The demand for goods and services is still running ahead of the economy’s ability to supply them, putting upward pressure on domestic inflation.......The effects of recent policy rate increases by the Bank are becoming evident in interest-sensitive areas of the economy: housing activity has retreated sharply, and spending by households and businesses is softening. Also, the slowdown in international demand is beginning to weigh on exports....... The Bank projects GDP growth will slow from 3¼% this year to just under 1% next year and 2% in 2024. 

On Canadian inflation: In the last three months, CPI inflation has declined from 8.1% to 6.9%, primarily due to a fall in gasoline prices. However, price pressures remain broadly based, with two-thirds of CPI components increasing more than 5% over the past year..... Near-term inflation expectations remain high, increasing the risk that elevated inflation becomes entrenched......The Bank expects CPI inflation to ease as higher interest rates help rebalance demand and supply, price pressures from global supply disruptions fade.....CPI inflation is projected to move down to about 3% by the end of 2023, and then return to the 2% target by the end of 2024.

The TL:DR version of this seems to be that the Bank believes its policy actions (and those of the Fed and others) are starting to have the desired effects, but it is still too soon to contemplate the much-discussed "pivot". All the same, it is surely significant that the Bank has opted for a smaller move this time, and it will be interesting to see whether other Central Banks are similarly inclined. Certainly, if the Fed shares the Bank of Canada's view that the US economy will show no growth in 2023, some similar policy signal will soon become appropriate there. 

One additional factor not mentioned by the Bank is the status of Canadian fiscal policy. For the first four months of the current fiscal year (which runs April-March), the Federal budget has been in surplus, and several Provinces are reporting similar results.  It is unlikely that this will persist at the Federal  level for the full fiscal year, but fiscal policy is providing very much less stimulus to the economy now than it did during the pandemic. This heightens the risk that monetary policy might overshoot what is needed to get inflation back to the target level.  

"The budget will balance itself"

Prime Minister Justin Trudeau has been mercilessly mocked for his claim way back in 2014 that "the budget will balance itself". It's an unfair criticism inasmuch as the offending phrase was the last part of a longer quote that's pure Keynesian logic:  "the commitment needs to be a commitment to grow the economy and the budget will balance itself".  Any politician who has tried to balance a budget through austerity -- we're looking at you, David Cameron, among many others -- would probably agree with the sentiment.

But never mind the theory, because right now in Canada, guess what's been happening? With the economy growing and the jobs market strong, revenues are soaring, even as the costs of COVID measures fall rapidly away. As a result, so far in fiscal 2022/23 (which began in April), the Federal budget is in surplus!  You can read all about it in the Fiscal Monitor, here. 

Now, it's true that the earlier months of Canada's fiscal years tend to produce smaller deficits than the later months. It's also true that the Government may well find itself tempted to spend some of this supposed windfall.  And there are signs that the economy is slowing down, even though it's not yet in a recession. So it's unlikely that Canada will end the fiscal year in surplus. Still, the recent data seem to support Trudeau's statement -- the full version of it, that is, not the five words that his opponents always focus on. We shouldn't expect Tory leader Pierre Poilievre to apologize or anything, but it would be nice to think someone has quietly brought this to his attention.

And by the way, it's not just the Federal finances that are improving. Oil producing provinces such as Alberta and Saskatchewan are rolling in dough. Even energy-poor Ontario racked up a small surplus in its last fiscal year. You're not reading much about all this in the media,  maybe because governments are feeling a bit sheepish about making out like bandits at a time when many Canadians are feeling the pinch.

Edging lower

Canada's September consumer prices data, released today by Statistics Canada, provide further evidence that the recent inflation spike has passed its peak.  Headline CPI rose 6.9 percent on a year-on-year basis, down from 7.0 percent in August and an apparent peak of 8.1 percent in June. The decline was somewhat smaller than markets had expected, but the month-on-month changes -- up 0.1 percent unadjusted, 0.4 percent seasonally adjusted -- point to a lower growth path for overall prices.

Once again StatsCan identifies the fall in gasoline prices as the key factor behind the improvement.  The year-on-year rise in this component slipped to 13.2 percent in September from 22.1 percent in August. The decline would have been larger (and thus the overall headline CPI figure slightly lower) but for a surge in retail gasoline prices in BC, the result of refinery shutdowns. Courtesy of the OPEC+ production cutback, gasoline prices have begun to move higher in October, so this component is not likely to provide further relief to overall inflation in the coming months. 

The news on food prices is much less positive. Prices for food purchased from stores accelerated to a gain of 11.4 percent in September from 10.8 percent in August. This is the fastest pace seen since 1981 and the gains are broad-based, with StatsCan identifying particular upward pressure for meat, dairy, baked goods and fresh produce. 

Excluding food and energy prices, CPI rose 5.4 percent year-on-year in September, up from 5.2 percent in August. All three of the Bank of Canada's special core measures of inflation posted exactly the same rate of increase in September as they had in August. It might be noted that the Bank is having some serious doubts about the usefulness of at least one of these aggregates -- CPI-common, which happens to be showing the highest inflation rate at the moment -- so they may play a smaller role in its decision making going forward. 

There is still no evidence of the dreaded wage-price spiral. Average hourly wages actually slowed to a 5.2 percent gain in September from 5.4 percent in August, well below the headline inflation rate. There are also signs that the Bank of Canada's tightening measures are having an impact on housing costs. Owned accommodation expenses and homeowners' replacement costs both slowed in September in line with the weakening housing market, though mortgage costs not surprisingly pushed higher. 

The Bank of Canada remains likely to raise rates further at its October 26 Governing Council meeting. However, the trends in wages and the housing market and the falling month-on-month pace of inflation mean that the case for further outsized rate moves is rapidly dwindling. 

 

"Thirteen years of Tory misrule", Part the Second

For anyone with any connection with or interest in the UK, the last few years have offered a deeply dispiriting spectacle, but it's one with a very obvious precedent.. Growing up in the London suburbs in the post-war era, one of my early memories of politics was the 1964 General Election. The Tories had been in power since 1951, and Labour leader Harold Wilson coined the phrase "thirteen years of Tory misrule" as one of his main election slogans. It worked and the Tories were booted out of office.

After spending most of my working life in Canada, I returned to live and work in the UK in 1998. It was in my mind to remain there for the rest of my days, but the election of David Cameron's Tories in 2010 filled me with trepidation, and a couple of years later we returned permanently to Canada. I don't even have a current UK passport any more. It turns out my fears for the future of the country were well-founded: I can't claim to have specifically predicted the disaster of Brexit or the clown-car politics of the last half-decade, but I was surely right to believe that the Tory party would prove totally unsuitable to govern the country in the modern era. 

So here we are approaching a second "thirteen years of Tory misrule" -- well, one year to go -- and the situation grows more dire by the hour.  Just before Boris Johnson took over as Prime Minister, the excellent London blogger Diamond Geezer wrote that "The UK's worst-ever Prime Minister, who took over from the UK's worst-ever Prime Minister, will soon be replaced by the UK's worst-ever Prime Minister".  Cameron to May to Johnson -- and now to Liz Truss, who makes her three predecessors look positively statesmanlike, no easy feat. And if you think that there surely cannot be anyone left in the Tory caucus who could be worse than Thick Lizzy, I simply suggest you Google "Suella Braverman".  

Truss is now, as the old saying has it, in office but not in power. It is clear that the country is now being run by Jeremy Hunt, who took over from the useless Kwazi Kwarteng as Chancellor of the Exchequer this past weekend.  Hunt has promptly torn up the economic stimulus package announced with much fanfare but disastrous results by Truss and Kwarteng just a couple of weeks earlier. Hunt is a safe pair of hands, relatively speaking -- I mean, he's still a Tory -- but he has a hell of a job on his hands, and the early signs are that he is going to mess it up in the usual ideological Tory way.

The fatal flaw in the Truss-Kwarteng package was that it consisted largely of giveaways to the rich that were supposed to boost economic growth but were wholly unfunded. With the public finances in a mess because of the cost of COVID measures, bond and currency markets took fright; mortgage rates soared and Sterling briefly looked likely to sink below parity with the US dollar.  Kwarteng tried to row back bits of the package but in the end Truss threw him under the bus -- or rather the plane, as he was in effect fired while on a late-night flight from a conference in Washington back to London.  

Hunt will be introducing a mini-budget of his own at the end of this month. Even though he has scrapped most of the Truss-Kwarteng mess, there is still a large gap in the public finances to be addressed if market turmoil is to be kept at bay. Hunt is being very clear that things are going to be difficult: he is talking of "eye-watering" spending cuts and hinting at tax rises,  two things which Truss had been adamant about avoiding but is now powerless to prevent.

So, here we go again.  The Cameron government back in 2010 tried to deal with the aftermath of the Global Financial Crisis through austerity measures, assuring the public that the fiscal deficit could be eliminated within half a decade. It never was, because as Tories never seem to understand, severe austerity measures cripple the economy and reduce revenues, making it all but impossible to balance the budget. 

It seems certain that Jeremy Hunt will make essentially the same mistake and the outcome will no doubt be the same too. It promises to be a tough few years for the UK economy. Will the era of Tory misrule extend beyond 13 years this time? It's too soon to tell -- an election is not strictly necessary until 2024 -- but it seems quite certain that the awful Ms Truss will not be around for very much longer. Quite the legacy she will be leaving!

Not good or not bad?

Equity markets have had a hard time deciding how they feel about the US CPI data for September, which were released this morning by the Bureau of Labor Statistics.  Stocks initially sold off sharply, with the DJIA more than 500 points lower, as the higher-than-expected monthly increase pointed to further aggressive Fed rate hikes, only to rally to an 800-point gain as the data were more fully digested. A look at the data themselves shows that there is plenty of scope for competing interpretations.  

Headline CPI rose 0.4 percent in the month, against market expectations of a 0.2 percent gain. This meant that the widely followed year-on-year rate edged down by just one tick, to 8.2 percent. This is a politically important number for the Biden administration, this being the last CPI report before the mid-term elections. 

But there are other ways of looking at the headline data. The 0.4 percent September print comes in the wake of essentially flat results for the two preceding months, meaning that the annualized "running rate" of inflation for the third quarter as a whole was not far from 2 percent, which is of course the Fed's target. The outsized monthly increases seen earlier in the year seem to be over.  Although it will take some time for the year-on-year numbers to reflect that, it is possible to make a case that the Fed is winning the inflation battle and can afford to take a more cautious policy approach going forward.  

That being said, the core CPI data tell a less encouraging story. That measure, which excludes energy and food prices, has shown no signs of the deceleration evident in the headline number. It increased 0.6 percent in September, the same as in August and in line with the pace seen since the start of the year. The year-on-year increase stood at 6.6 percent, the largest since August 1982. This evidence of continuing broad-based price pressures could lead the Fed to continue with the very aggressive tightening seen so far this year, and that was certainly the markets' interpretation immediately after the numbers were released. 

Faced with this mixed bag of data, which way will the Fed go at the next FOMC meeting, set for November 1-2?  There is a growing chorus of commentators warning that the Fed is risking a severe recession by pursuing an aggressive tightening policy that can do little about the underlying causes of the recent inflation spike. Recent rhetoric from Fed officials suggests that they are not being swayed by this line of argument, so another large move is on the cards.  

Just as an afterthought, today's numbers have an impact on Canada too. The Canadian dollar sold off after the CPI release, on expectations that the Bank of Canada may not look to match the expected pace of Fed tightening.  Persistent weakness in the exchange rate would soon spill over into Canadian inflation data. Canada's September CPI data, due for release on October 19, are likely to show some further moderation, but that may not be sufficient to keep the Bank of Canada from tightening further. 

Phillips Curve Redux?

Back in my undergraduate days (at the end of the 1960s, if you're asking), the Phillips curve was a significant part of the macroeconomics courses. The original paper by William Phillips, published in 1958,  posited an inverse relationship between the unemployment rate and wage gains. By the time I was at university, other economists had broadened this out to suggest an inverse relationship between unemployment and inflation itself. You can read the history of the concept here. 

I was never a great fan of the Phillips curve, not least because the original data plot (embedded in the linked article) did not exactly show what you would call a robust relationship. Later analyses have also tended to show that the concept is too simplistic a representation of complex economic relationships to be of much use as either a forecasting tool or a guide for policymakers.

It's surprising, then, to find that here in 2022, monetary policy in the major economies seems to be driven by Phillips's ideas. The Federal Reserve is openly admitting that the rapid monetary tightening of the past several months is aimed at calming labour markets (i.e. raising unemployment) in order to get inflation down to the 2 percent target. The Bank of Canada and the Bank of England are using similar logic in setting their own policies. 

The problem with this should be apparent. The recent inflation spike is largely the result of global supply chain pressures, initiated by the COVID pandemic and exacerbated by the Russian assault on Ukraine. There is little or no resemblance between these circumstances and those which the Phillips curve attempted to describe. Hence there is little good reason to think that slowing the economy and raising unemployment will do much to reduce inflation. To put it another way, it is very difficult indeed to know just how high unemployment might have to go in order to curb inflation that has almost nothing to do with tightness in labour markets.

All of which is offered by way of introduction to the September jobs market data for the US and Canada, released this morning. In both countries, the data were a little stronger than expected, which immediately prompted markets to increase their bets on further aggressive rate hikes.  It may be that neither the markets nor central bankers really believe in the Phillips curve, but right now both are acting as though they do. 

In the US, the BLS data show that employment rose by 263,000 in September, slightly above market expectations. This pushed the unemployment rate a tick lower, to 3.5 percent. The monthly gain is well below the average posted so far this year, which stands at 420,000, but there is no doubt that the jobs market is still tight, despite the lack of GDP growth so far this year. Still, there is not much evidence that this tightness is pushing wages higher: average hourly earnings rose 5.0 percent in the year to September, more than three percentage points below the latest headline CPI print. No wage-price spiral there.

As for Canada, StatsCan reported today that employment rose by 21,000 in September. The unemployment rate dropped by 0.2 percentage points to 5.2 percent, driven not only by the rise in employment but also by a slightly surprising fall of 20,000 in the number of people looking for work. The rise in employment largely reflected a rebound in employment in the educational sector, which underwent a large and unexplained fall in August, so the headline numbers may overstate the underlying strength in the jobs market. That said, the market is still tight, with high vacancy levels, yet there is still little sign of wage pressures: hourly wages rose 5.2 percent in the year to September, well below the 7 percent gain posted by CPI. 

Even before the data appeared, both Fed and Bank of Canada spokespersons had stressed their belief that further rate hikes would be needed to get inflation back to the target range. The Fed may well be looking at yet another 75 basis point hike next time out, while the Bank of Canada may throttle back to 50 basis points, unless it is spooked by the weakness in the exchange rate. One wonders what William Phillips, the very definition of what Keynes long ago referred to as "some defunct economist", would think of all this. 

And still it grows

The Canadian media have been crying recession ever since the Bank of Canada started raising rates at the start of the year. So far, the actual economy is refusing to play along. Statistics Canada reported today that real GDP rose 0.1 percent in July, reversing its preliminary forecast of a 0.1 percent decline. Preliminary data for August call for a flat outcome. 

In truth, there is not a whole lot to like about the July data, though it is remarkable to see the Canadian economy still performing significantly stronger than the US. Growth in July was led by the goods-producing sectors, which showed a 0.5 percent gain. This was the result of particular strength in resource extraction (up 1.9 percent) and agriculture (up 3.2 percent).  This was partly offset by a 0.5 percent fall in manufacturing output, led by durable goods, marking the third decline in this sector in the last four months. 

The services sector posted a 0.1 percent decline in the month. Both wholesale and retail trade declined, as did the restaurant sector.  Real estate agents and brokers saw a fifth straight month of falling activity, evidently a reflection of the tighter policy settings at the Bank of Canada. However, activity in the public sector posted a 0.4 percent monthly gain. In all, just eleven of the twenty sub-sectors tracked by StatsCan posted higher output in the month. 

In sum, the Canadian economy is clearly on a significantly slower growth path, but is nowhere close to any reasonable definition of recession, however galling that fact may be to the headline writers. That being said, the economic background against which the Bank of Canada makes its policy decisions has clearly shifted. Slower growth, evidence that the domestic inflation cycle has peaked and growing skittishness in global financial markets all point to the need for much less aggressive policy actions in the months ahead. 

Down the khazi with Kwasi?

Back in 1972, the UK's Conservative Government was in trouble, amid economic stagnation and worker unrest, and with a general election due in less than two years. I was living there at the time, a recent graduate employed at the Foreign Office in Whitehall.  Chancellor of the Exchequer Tony Barber tabled a highly irresponsible budget designed purely to put the Tories in a position to win the next election. 

The Tory media were predictably laudatory. One of the tabloids, possibly the Daily Mail, ran a front page with a cartoon of a jet with Barber's face, with the headline "Take off with Tony". The rest of the page described the budget in large print as "the roaring, soaring giveaway that knocks all others flat".  It produced a short-lived "Barber boom", but soon set the UK onto a boom-and-bust trajectory that persisted for better than a decade. And despite it all, Labour came to power in 1974. 

The UK media are comparing today's mini-budget tabled by rookie Chancellor Kwasi Kwarteng to Barber's disastrous experiment, and not without reason. PM "Thick Lizzie" Truss had already announced a wildly expensive plan to protect consumers and industries against rising fuel prices, eschewing the logical option of a windfall tax on energy company profits and opting instead to ramp up borrowing. Kwarteng's package of tax cuts and other measures, almost exclusively to the benefit of the most well-off, will further boost the UK's borrowing requirements, all while adding to inflationary pressures. 

Small wonder, then, that Sterling has tumbled below US$1.10 and Gilt yields have soared. No less an eminence than Larry Summers has opined that "Britain will be remembered for having pursued the worst macroeconomic policies of any major country in a long time".  Even the reliably pro-Tory Daily Mail is aghast, reminding its readership of the disaster that followed Barber's budget, though not reminding those readers that at the time, it thought Barber's budget was a damned fine thing.  

Truss has a solid majority, so the chances of  the Tories being ejected from office early are slim. Based on her first three weeks in office, she looks capable of doing a whole lot of damage. 

Fed sticks to its task

In line with market expectations, the Federal Reserve today imposed its third straight 75 basis point increase in the funds target range, which now stands at 3.0 - 3.25 percent. The press release signals there are more rate hikes to come, and also commits the Fed to continuing its policy of quantitative tightening. 

As was the case after the last rate hike, the press release's discussion of the economic background to its decision is skimpy. It almost seems that the Fed is saying to markets, "if you don't understand what we're doing by now, you are never going to understand".  Apart from a short paragraph on the impact of Russia's depredations in Ukraine, this is the entire text on the economy:

Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.

Nothing very controversial there. What is striking is that the release offers no hints that the Fed yet sees any indications that its tightening policies are having the desired effect on either the real economy or inflation. Nor is there any mention of inflation expectations, even though keeping these in check is surely the main goal of this series of sharp rate hikes -- after all, there is not much that monetary can realistically do about the underlying causes of the recent inflation spike. 

There seems to be at least some risk that the Fed is too busy looking in the rearview mirror to see that there may be a turn coming. It is true that headline CPI is still way above target on a year-on-year basis, but that will inevitably remain true for some months to come because so many of the high monthly prints from late last year and early this year are baked into the calculation. The last two monthly prints have been much lower, possibly signalling a change in the underlying trend. 

That being said, there are still reasons for the Fed to be cautious. First, the recent lower CPI data have been heavily influenced by one factor -- gasoline prices -- and signs of a slowdown in wider inflation pressures remain elusive.  Second, until there is clear evidence of a decline in inflation expectations, the Fed will feel it cannot afford to take its foot off the brake. 

So how much further do rates have to rise? A glance at the chart deck released today tells us that the median expectation of the FOMC members for the funds rate in 2023 is now 4.6 percent, up a startling 80 basis points from the June projection. Even for 2024, the median projection is barely below 4 percent. Evidently the FOMC believes that it will take a prolonged period of high rates to get inflation back to the target. It's getting harder to believe that this scenario is compatible with anything like a soft landing for the real economy. 

Slowly but surely

Canadian CPI data for August, released by Statistics Canada this morning, suggest that we may now be past the worst of the recent inflation spike. On a year-on-year basis headline CPI slowed more than expected, falling to 7.0 percent from the 7.6 percent  recorded in July and 8.1 percent in June, which now seems likely to have been the peak. Monthly numbers, which are arguably more relevant* than the yearly numbers at turning points, provide even stronger evidence of the emerging trend: unadjusted CPI fell 0.3 percent in the month, the biggest decline since early in the COVID pandemic, while the seasonally adjusted headline number rose 0.1 percent, the smallest rise since December 2020. 

As was the case in July, falling gasoline prices accounted for much of the improvement in headline inflation. Gasoline prices once again fell by more than 9 percent month-on-month, though they remain more than 22 percent higher than a year ago. Even stripping out gasoline prices, the August data show some sign of a changing trend: the year-on-year increase for CPI excluding gasoline slowed to 6.3 percent from 6.6 percent a month earlier, the first deceleration in this measure since June 2021. 

The most concerning aspect of the latest data continues to be the performance of food prices. Grocery prices rose 10.8 percent from a year earlier, the fastest pace seen since 1981, and StatsCan characterizes the increase as "broad-based". Excluding both food and energy, the increase in CPI was 5.3 percent, down from 5.5 percent in July. 

The Bank of Canada's preferred core measure of inflation, which have been rising inexorably for many months, finally went into reverse in August. The mean value of these three measures slipped by about 0.2 percent in the month, to just over 5.2 percent.

The clear evidence of a turning point in CPI growth will obviously factor in to the Bank of Canada's rate decision in October. It is unlikely that we will see any more outsize rate hikes in this cycle; a 25 basis point move is altogether possible.  The likelihood that the Bank may now be on a less aggressive tightening track than the Federal Reserve is contributing to the moderate weakening in the Canadian dollar, which could add to Canadian inflation in the medium term. However, amid signs that rate hikes are having a growing impact on the domestic economy, particularly the housing sector, the Bank is unlikely to react strongly to the falling exchange rate. 

* This is a point that the media seem determined to overlook. The year-on-year CPI increase is composed of twelve separate monthly data points. The older numbers, which were considerably larger than those we are now seeing,  only fall out of the index one at a time. Focusing on the year-on-year data as a guide to Bank of Canada policy is like driving while looking in the rear view mirror. We can hope that the Bank knows better. 

What's going on?

Canadian employment data continue to be both worrying and hard to parse. Statistics Canada reported today that employment fell by 40,000 in August, its third consecutive decline.  Employment has fallen by a total of 114,000 since May. This month's decline served to push the unemployment rate up by half a percentage point, to 5,4 percent. 

The fall in employment was concentrated in two sectors: education lost 50,000 jobs in August, while employment in construction was down 28,000. These losses were only partly offset by gains in parts of the services sector.  The job losses in education may well be largely seasonal in nature and may be reversed in September.  However, the significant decline in construction employment may be an early indication that the Bank of Canada's rate hikes are starting to have an effect. If the Bank indeed had an sneak peek at these numbers before Wednesday's rate announcement, its decision to proceed with a further 75 basis point rate hike looks questionable. 

There is one element of the data that will raise concerns at the Bank. Average hourly wages rose 5.4 percent in the year to August, up from 5.2 percent in each of the two preceding months. This is still far short of the rise in consumer prices, most recently reported at 7.6 percent, but it shows that any incipient weakness in the jobs market has not yet had any dampening effect on wages.

The employment data are hard to square with the available data on the real economy, with real GDP growing in both Q1 and Q2 and falling only marginally in July.  In addition, anecdotal data continue to suggest that employers are having trouble finding the staff they need -- our local Tim Hortons was closed once again yesterday evening!  Still, three months of weakness in employment cannot be ignored by policymakers if their goal is to produce a soft landing rather than a recession. It seems quite certain that we are much closer to the end of the tightening cycle than the beginning. 

Beyond neutral

In line with market expectations (though not this blogger's; mea culpa), the Bank of Canada raised official interest rates by 75 basis points today. The overnight rate target is now 3.25 percent, just above the 2.5-3.0 percent rate the Bank (and markets) consider to be "neutral".  The generally hawkish tone of the press release suggests there are more hikes to come.  

That press release notes that the domestic economy remains strong, though there are signs that things may slow down in the second half of this year as the impact of policy tightening starts to be felt:

The Canadian economy continues to operate in excess demand and labour markets remain tight. Canada’s GDP grew by 3.3% in the second quarter. While this was somewhat weaker than the Bank had projected, indicators of domestic demand were very strong – consumption grew by about 9½% and business investment was up by close to 12%. With higher mortgage rates, the housing market is pulling back as anticipated, following unsustainable growth during the pandemic. The Bank continues to expect the economy to moderate in the second half of this year, as global demand weakens and tighter monetary policy here in Canada begins to bring demand more in line with supply.

As for inflation, the Bank sees little reason for optimism in the near term, and continues to fret about the risk that expectations of persistently high inflation may become entrenched:

CPI inflation eased in July to 7.6% from 8.1% because of a drop in gasoline prices.  However, inflation excluding gasoline increased and data indicate a further broadening of price pressures, particularly in services. The Bank’s core measures of inflation continued to move up, ranging from 5% to 5.5% in July. Surveys suggest that short-term inflation expectations remain high. The longer this continues, the greater the risk that elevated inflation becomes entrenched.

One development that may be causing heightened concern for the Bank is the way Canadian households are dealing with the rising cost of living. Surprise, surprise, they are borrowing more. A new report from TransUnion Canada shows that consumer debt in Q2 stood 9.2 percent higher than a year earlier and 16 percent higher than before the pandemic.  Although delinquency rates remain low, this must be expected to change as higher rate begin to bite. Forget the political squabbling over the state of public finances: it is the financial health of the household sector that currently poses the greater threat to Canada's financial stability, given debt levels and the abrupt correction in the housing market. 

At the conclusion of the press release, the Bank's Governing Council still judges that the policy interest rate will need to rise further. However, it is reasonable to surmise that the phase of outsize rate hikes is at an end. After a disastrously late start, the Bank has now raised rates by 300 basis points in little more than half a year. A reversion to more customary 25 basis point increments is now in the cards, and if the bite on household finances continues to worsen, we may soon be at the end of this tightening cycle. 

A turning point?

First the good news: Canada's real GDP rose at a 3.3 percent annualized rate (0.8 percent quarter to quarter) in Q2, according to data from Statistics Canada this morning. This marks the fourth consecutive quarter of real growth and stands in marked contrast to the US, where real GDP declined in both Q1 and Q2. Much of the growth resulted from business inventory accumulation, which may prove a mixed blessing if we are in fact about to see a shift to slower growth or even recession. Both housing investment and durable goods spending fell in the quarter, which may well indicate that higher interest rates are already having an impact. 

Given mounting concerns over the possibility of a pause in growth,  monthly GDP data are arguably more informative at present than the quarterly figures.  Here, the data also published today by StatsCan provide a mixed picture. Real GDP rose 0.1 percent in June after rising only minimally in May.  (It is worth noting that the May data originally showed a 0.1 percent decline, which immediately led the media to start proclaiming a recession).  Growth in June was reasonably broad-based, with fourteen of the twenty industrial sub-sectors showing gains. The accommodation and food services sector was particularly strong as border restrictions continued to ease. 

Advance data for July seem to tell a different story. StatsCan estimates that GDP fell 0.1 percent in the month, with manufacturing, wholesale and retail trade and utilities all posting declines. If final data (due on September 29) confirm this, it will imply that GDP is essentially unchanged from April, which was the last month to post really solid gains. This does not meet any sensible definition of a recession, but it does suggest that the economy has moved from the post-COVID recovery phase to a much lower growth path. 

Such a slowdown is, of course, what the Bank of Canada is trying to achieve, given its clear concerns about overheating in the economy, particularly in the labour market. Today's data are among the last major indicators the Bank will see before its next rate decision, due on September 7: the all-important employment and CPI data for August will not be published until later in the month, though it is likely that the Bank will have advance knowledge of the jobs data when it meets to make its rate decision. After the outsized rate hikes at the last two meetings, expect the Governing Council to settle for a more modest 50 basis point hike this time. 

Canada's budget surplus (yes, really)

Not getting much attention in the media, but Canada's Federal budget has swung sharply into surplus so far in fiscal year 2022/23, which began in April. Data released by the Department of Finance this morning show a surplus for the three months April-June of C$ 10.2 billion, compared to a deficit of C$ 35.6 billion in the corresponding period last year.

Most people's first guess, including mine,  would be that the improvement is largely down to rising revenues, particularly in light of the surge in energy prices. It turns out this is not entirely the case. To be sure, revenues are up sharply -- more than 20 percent, in fact -- but the Fiscal Monitor describes the rise as "broad based". The biggest contributors are corporate and personal income tax revenues, consistent with the ongoing recovery in the economy. However, a bigger contribution to the turnaround can be found on the spending side: program outlays fell 25 percent, largely as a result of declining transfers to persons, through falling unemployment benefit payouts and the virtual elimination of COVID-related transfers. 

The data almost totally destroy the arguments about fiscal policy being put forward by the likely new Conservative Party leader, Pierre Poilievre. His view that what he calls "Justinflation" is entirely the result of out-of-control public spending financed by the Bank of Canada's printing presses was never remotely accurate and now looks totally asinine.  So far, no comment on the data from the Poilievre camp. Well, it is the last Friday in August, after all. 

Leaving aside the politics of all this, it's worth asking whether the swing into surplus is actually a good thing. After several years of dismal fiscal results, it is useful to have a reminder that strong economic growth is almost always the best way to solve a fiscal problem. Justin Trudeau's much ridiculed statement that with a growing economy, "the deficit will fix itself" is much more true than not. 

The flipside of this, however, is that fiscal policy is for the moment, rather unexpectedly, working alongside monetary policy to put the brakes on the economy. This may help get inflation back to target rather sooner, but obviously heightens the risk of tipping the economy into recession. If the good fiscal news continues, expect some sort of mini-budget in the Fall where the Government can spend some of this unexpected windfall. 

Gissa job

Outdated numbers, sure -- they're for June -- but still worth reporting as the media continue to stoke recession fears in Canada: Statistics Canada reports today that payroll employment rose by 114,000 in June, while the number of job vacancies rose by 32,000, resulting in a job vacancy rate of 5.9 percent, matching the record high for the series. 

The data come from the Survey of Employment Payrolls and Hours or SEPH. This is completely separate from the more familiar monthly labour force survey (LFS). That survey has shown some modest weakness in the last two reporting months (June and July),  while still suggesting that the Canadian jobs market is extremely tight by all historical standards. The SEPH results seem to confirm that.

Both sets of data are consistent with anecdotal evidence in my own home region and all across the country. Employers are finding it difficult to source enough employees to run their businesses the way they did before the COVID pandemic. Here in Niagara, for example, at the height of the all-important tourist season, restaurants are having to close for parts of each week because of lack of staff, while local stores are having to tempt retirees back into the labour force in order to keep their doors open. 

Can it continue this way? The anecdotal evidence suggests that the situation certainly hasn't changed in the two months since the SEPH data were collected. However, it is worth remembering that employment data tends to lag behind economic activity data, such as GDP, both on the upward and the downward side of the business cycle. Recall that Canada's GDP growth, in contrast to that of the US, appears to have remained positive through the first two quarters of the year. It may be that things have weakened in the current quarter, which would suggest that employment data might take a turn for the worse in the next few months. For now, though, there's no real evidence of that.  

Who cares who cares?

The summer months have seen Ontario media crammed with stories about the supposed collapse of the Province's healthcare system.  A vanishingly small number of short-term emergency room shutdowns has been offered as evidence that the entire system is "on the brink".  An unholy alliance has sprung up almost overnight. Commentators on the left, led of course by the Toronto Star,  argue that the fault lies with the Doug Ford government, while those on the right want to see further privatization in order to ease pressure on the system.

As it happens, yours truly has had lots of exposure to the health care system in the last two months, as my wife has received a hip replacement.  There have been countless visits to hospitals, diagnostic centres, physios and such. There have been no issues at any stage of the process, and no signs of the burnout, staff morale problems and all the rest of it that we read about every single day.  It's dangerous to generalize from a single example, but if our experience in our very unfashionable small city is anything to go by, the health system remains resilient.

It's worth pointing out that the Ontario health system is by no means exclusively a public sector operation. Hospitals are public, but there is no public dental care whatsoever, eye care is a mixture of public and private, there is no pharmacare except for seniors and most diagnostic centres (blood tests and such) are privately operated. Wall-to-wall TV ads offering insurance for "the things your public health plan doesn't cover" offer all the evidence you need that the system is already far from comprehensive.

Be that as it may, the Ford government is not about to let a good crisis go to waste, and today unveiled a multi-part plan to relieve the pressure on the system. One element of the plan calls for allowing private clinics to offer a wider range of procedures while making sure that costs are still covered by OHIP, the Province's health care plan.

It's not at all clear why this would be a better or lower-cost option than simply increasing funding for the public system. At the start of this century I spent more than a decade living in the UK, which has a mixed public and private health care system. I could write a whole post about this, but one observation that's relevant here is that the private sector goes after the low-hanging fruit. They'll schedule you for a hip replacement if it looks likely to be a simple procedure, but if there's any risk of complications they'll boot you back to the nearest public hospital before your ass hits the gurney.  

Supporters of greater private sector involvement in health care point to a variety of countries that have a blended system and deliver better outcomes than Canada at a lower cost; France and Spain are two regularly cited examples. Fair enough, but does anyone really believe that opening up the Ontario health system to private money would move us in that direction? Far more likely that an influx of money and methods from across the border to our south would push up costs and rapidly erode the equal access that we currently enjoy. I'll take a pass, thanks.

Behind the headline

Sure, the headline numbers from Canada's July consumer prices report look good. StatsCan reported this morning that the year-on-year rise in headline CPI slipped to 7.6 percent in the month from 8.1 percent in June, breaking a year-long streak of ever-higher inflation. The month-on-month increases -- 0.1 percent unadjusted, 0.3 percent seasonally adjusted -- were the smallest since December 2021. 

All well and good, but you only have to read as far as the second sentence of the press release to realize that there may be less to this improvement than meets the eye: "The deceleration was a result of slower year-over-year growth in gasoline prices". That bald statement of fact says it all: aside from the fall in the price of gasoline, it is difficult to spot much really encouraging news in this report. 

Gasoline prices fell 9.2 percent in July, dropping the year-on-year increase in this key component to 35 percent from the alarming 55 percent recorded in June. However, a quick glance at most of the other measures in StatsCan's summary table makes it clear that price pressures remain broad-based. In particular, food prices actually accelerated on a year-over-year basis in July, rising 9.9 percent after a 9.4 percent rise in June. Excluding both food and energy, prices rose 5.5 percent year-on-year in July, well above the Bank of Canada's 2 percent target.

The special aggregates developed by the Bank to monitor core inflation trends also offered little solace. Two of the three measures rose in July; all three are now at or above 5 percent, with the mean reading edging up to 5.3 percent. 

Even with all these caveats, it seems likely that the peak of the current inflation spike has passed, but the headline rate will decline only slowly from here. Gasoline prices may have slid in July, but they continue to fluctuate wildly on a daily basis, making it hard to get a handle on how the August index may be affected. Looking further ahead, natural gas prices may well supplant gasoline as the top-of-mind concern for Canadians as the colder weather approaches: the year-on-year increase for natural gas in July, at 42 percent, was actually higher than the increase for gasoline.  

It seems clear that the Bank of Canada will raise rates again at its next Governing Council meeting in September, but a 50 basis point move seems more likely than the much bigger increases seen in recent times.  There are still no signs of an emerging wage-price spiral, with the rise in wages, at 5.2 percent, lagging far behind CPI. Moreover, the Bank's tightening up to this point has put the housing market sharply into reverse, with both sales activity and prices falling sharply. By further undermining the housing market, aggressive rate hikes from here could seriously damage consumer confidence. That would make the soft landing for the economy that is the Bank's stated goal all but impossible to achieve.