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.