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.