Canada's Federal budget: anchors aweigh

Justin Trudeau became Prime Minister of Canada in October 2015 partly on a promise to run small fiscal deficits for just a few years in order to boost the economy.  There was always supposed to be a plan to move the budget back into balance, and in the meantime the debt/GDP ratio would serve as a backstop fiscal anchor to keep deficits and debt from getting out of hand. It became clear quite quickly that the deficits would be bigger and more persistent than Trudeau had intimated -- and then came the COVID crisis, to which the government quite correctly responded by hugely boosting spending and the deficit. 

As the threat from COVID eased, the budget deficit began to fall quite rapidly, but in the last couple of years Trudeau and his Finance Minister Chrystia Freeland have made it clear that they have no intention of reining in the government's finances. The 2024 Federal budget, unveiled by Freeland on Wednesday, indicates that all of the fiscal checks and balances promised back in 2015 have been abandoned.

You can read a summary of the government's proposals here. As promised in Trudeau's pre-budget cross-Canada tour, there is heavy emphasis on measures to boost housing availability and affordability  -- in effect, attempting to solve problems that have in large measure been created by the government's own out of control immigration policies.  There are a few revenue-raising measures, of which the most significant is a boost in capital gains taxes. This is supposed to raise something like C$ 20 billion, even though it is targeted only at the wealthiest 0.13 percent (really!) of taxpayers.

The end result of this is a string of deficits stretching out over the usual five-year planning horizon. The deficit for the just completed fiscal year 2023/24 was C$ 40.0 billion. It is projected to be remarkably sticky this year and next, at C$ 39.8 billion in FY 2024/25 and C$ 38.9 billion in FY 2025/26.  After that, the deficit magically starts to fall much faster, but even by the end of the planning period, FY 2028/29, it is still projected to be C$ 20.0 billion. Every single one of these numbers is higher than was projected in the Fall Economic Statement back in November. And the fact that the deficits seem to fall faster in the "out years" is of course completely bogus, with an election due by October 2025 at the latest. We seem to be back to the kind of budgetary forecasting that got Canada into a fiscal mess under Tory governments back in the 1990s.

There is nothing wrong with deficit financing in principle. The idea that deficits always cause inflation is wrong; so is the idea that government financing needs "crowd out" private sector borrowers. And anyone who followed the ill-fated austerity approach followed by the UK government after the global financial crisis surely knows that you can never correct a budget deficit by squeezing the economy. The only true constraint on the economy is the availability of real resources, be they labour, capital goods or raw materials. As Keynes famously put it, "anything we can do, we can afford".

That's precisely the issue here. The Bank of Canada has had to keep interest rates uncomfortably high for a long time because the economy has been running very close to full capacity, or full resource utilization if you prefer. Bank Governor Tiff Macklem has subtly suggested more than once that high  government spending has made the task of reducing inflation much harder than it needed to be. 

It's arguable that the recent uptick in the unemployment rate has eased some of those concerns, something the Bank has acknowledged in its policy pronouncements.  However, it is not clear that the pool of available workers, which largely consists of new arrivals and job-seeking college graduates, matches the current needs of the economy. To take just one example, the budget's commitment to build over 3 million homes by 2031 is going to require an awful lot of skilled construction workers. It is not at all clear where those people will be found. 

Announcing its most recent monetary policy decision, the Bank of Canada projected that the economy would start to move out of its recent mini-slump after mid-year. As a result, the small amount of excess supply that has emerged over the past several months will quickly be eliminated, which would serve to put a floor under just how low the Bank can lower interest rates without reviving inflationary pressures. This Federal budget, which has been roundly condemned by such worthies as former Finance Minister Bill Morneau and former Bank of Canada Governor David Dodge, looks certain to continue to make the Bank's job more difficult in the coming years.

What a choice Canadians face when the election finally rolls around. The abrasive Tory leader Pierre Poilievre and his seriously inexperienced team, or the experienced but reckless Trudeau/Freeland combo. Polls say the election is Poilievre's to lose, and there does not seem to be much in the budget to change that. 

Canada CPI: could have been worse

The sharp snap-back in US CPI for March that was reported last week led to concerns that Canada might see a similar unwelcome development when its own data were released. Today Statistics Canada reported that inflation did indeed tick higher in March, but much less sharply than in the US. Headline CPI rose 2.9 percent from a year ago, up from the 2.8 percent recorded in February, thus staying just below the upper limit of the Bank of Canada's target range.   

The data have led to a sigh of relief in financial markets, on the basis that a rate cut in June remains "within the realm of possibility", as Bank of Canada Governor Tiff Macklem put it last week. But before we look at the details of today's report, it is worth noting that the month-to-month changes tell a less hopeful story than the year-on-year figures do.  Before seasonal adjustment, CPI rose 0.6 percent from February to March, while the seasonally adjusted index rose 0.3 percent. If the Bank is looking for evidence that the deceleration in CPI is being sustained, these numbers do not provide it. 

In terms of the main contributors to the rise in CPI, we are yet again looking at the usual suspects: shelter costs and gasoline prices. Shelter costs are up 6.5 percent from a year ago, with rents 8.5 percent higher and mortgage interest costs up 25.4 percent. That last number is within the direct ambit of the Bank of Canada, but the overall increase in shelter costs is also heavily influenced by the very rapid, largely immigration-driven increase in Canada's population. 

Gasoline prices rose 4.5 percent in March, mainly in response to international developments, to stand 4.9 percent higher than a year ago. With international tensions ratcheting yet higher, gas prices are set to boost headline CPI again in April. On top of that there is also the increase in the Federal carbon tax, which took effect on April 1, to be reckoned with, though it is noticeable at least in my local area that that increase does not seem to have had much impact on prices at the pumps.

Turning to the widely-followed special aggregates, we find that almost all core measures -- ex food, ex energy, ex gasoline, ex food and energy -- have all slipped just below 3 percent. Goods prices are up just 1.1 percent from a year ago, but services prices have risen 4.5 percent, which will be a concern for the Bank of Canada.  The Bank's own preferred gauges of core inflation all edged lower in March, with their mean level now standing just below 3 percent. These numbers all seem to support the notion that a rate cut could some as soon as June 5. 

With the inflation numbers out of the way, attention now turns to the Federal budget, set to be tabled later this afternoon. We await this with less than bated breath, since PM Trudeau has spent the last several weeks gallivanting about the country making extravagant spending promises, mostly relating to housing. The only surprise left for Finance Minister Freeland to unveil is whether she will be raising taxes in order to avoid ballooning the deficit. (Spoiler alert: probably).

The Bank of Canada will be watching the budget closely, of course.  Governor Macklem has hinted several times that public spending is serving to boost the economy, which obviously makes it harder for the Bank to get inflation down and start cutting interest rates. With the government clearly gearing up for an election, Macklem's message seems likely to fall on deaf ears.

Bank of Canada: we're getting there

As expected, the Bank of Canada kept its overnight rate target unchanged at 5.0 percent today. The media release was rather longer than usual, reflecting the fact that the Bank also issued an updated Monetary Policy Report. Based on the media release and Governor Macklem's subsequent comments, most analysts believe that a rate cut in June is still probable, but the latest inflation developments in the US may yet delay things. 

Key quotes from the media release include:

• The Bank has revised up its forecast for global GDP growth to 2¾% in 2024 and about 3% in 2025 and 2026. Inflation continues to slow across most advanced economies, although progress will likely be bumpy. Inflation rates are projected to reach central bank targets in 2025. 
• In Canada, economic growth stalled in the second half of last year and the economy moved into excess supply.....the unemployment rate has risen gradually, reaching 6.1% in March. There are some recent signs that wage pressures are moderating.
• Economic growth is forecast to pick up in 2024. This largely reflects both strong population growth and a recovery in spending by households.......Overall, the Bank forecasts GDP growth of 1.5% in 2024, 2.2% in 2025, and 1.9% in 2026. The strengthening economy will gradually absorb excess supply through 2025 and into 2026.
• CPI inflation slowed to 2.8% in February.....However, shelter price inflation is still very elevated, driven by growth in rent and mortgage interest costs. Core measures of inflation....slowed to just over 3% in February, and 3-month annualized rates are suggesting downward momentum. The Bank expects CPI inflation to be close to 3% during the first half of this year, move below 2½% in the second half, and reach the 2% inflation target in 2025.

All in all, this sounds very much like the soft landing that the Bank and its peers around the world have been striving to achieve.  Even so, the Bank is not quite ready to commit to a rate-cutting cycle just yet. As the media release puts it, and as Governor Macklem repeated in his comments after the rate announcement, "While inflation is still too high and risks remain, CPI and core inflation have eased further in recent months. The Council will be looking for evidence that this downward momentum is sustained".  Analysts' interpretation of this is generally that the Bank just needs to see "more of the same" before it starts cutting rates. It will have two more months of CPI and employment data to hand by the next rate announcement date on June 5, and that data will be crucial to its decision.

The importance of ensuring that progress against inflation is "sustained" is underscored by the US CPI data for March, released just ahead of the Bank of Canada's announcement this morning. Headline CPI jumped to 3.5 percent year-on-year from February's 3.2 percent reading, driven by shelter and gasoline costs, while core CPI stands at 3.8 percent year-on-year.  The data drove US markets sharply lower and led many analysts to all but rule out any possibility of a Fed rate cut in June.

There is no direct link between US and Canadian inflation, but gasoline and shelter costs are a big part of the index in both countries. A similar nasty shock in Canada's CPI in the next month or two, most likely due to gasoline prices, cannot be ruled out.  There is no doubt that the Bank of Canada would like to get started on an easing cycle, with the Canadian economy notably underperforming the US in recent months, but the data could yet derail expectations for a June rate cut. 

Disturbing data divergence

Data from the Bureau of Labor Statistics show that US employment rose by 303,000 in March, far surpassing economists' expectations. (Details here).  This has triggered the usual debate among media pundits about why US voters still seem to have such a negative view of the economy. The answer this month, as it has been for the last year and more, is inflation. In a low unemployment economy, almost no-one is concerned about losing their job, but everyone sees that prices are much higher than they were before the "transitory" inflation spike began.  We can but live in hope that the media will figure this out eventually.

Meanwhile in Canada, the March data tell a very different story. According to Statistics Canada, the economy actually lost a little over 2000 jobs in March. This is well within the standard error of the estimate -- remember, this is a survey, not a complete count -- but it comes at a time when the labour force is still growing at an extraordinary pace. Canada's population grew by 90,000 in March, to stand more than 1,040,000 higher than a year earlier.  The labour force grew by 57,000 in March and is now 570,000 larger than a year ago.

Looking at these numbers in percentage terms, we find that even with the marginal decline in March, employment has grown by 1.6 percent in the past year, by no means a bad number.  However, this is far outpaced by the growth in population -- up 3.2 percent from a year ago -- and the labour force, up 2.7 percent in the same time period. It is thus no surprise to find that the employment rate has been going down -- it now stands at 61.4 percent, down 0.9  percentage points from a year ago -- and the unemployment rate has been steadily rising. That rate jumped 0.3 percentage points in March to hit 6.1 percent, a full percentage point higher than it was a year ago.

The Bank of Canada will not want to react too much to a single data point, especially given the notorious volatility of Canadian job statistics. However, today's data will certainly add to the growing calls for the Bank to make an early start on the much-anticipated rate cutting cycle. One problem there: wage growth actually ticked slightly higher in March, to 5.1 percent year-on-year, an uncomfortably high number given Canada's very poor productivity performance. The first rate cut is still not likely to materialize before June, but it looks likely that the Bank will have to cut more aggressively than the Fed, which will probably put pressure on the exchange rate.

The rising unemployment rate is not good news for Justin Trudeau, who has been whirling around Canada like a dervish, announcing major new spending ahead of the April 16 budget. This week he directly addressed the impact of high immigration levels, telling an audience in Nova Scotia that the growth in "temporary" immigration has been "far beyond what Canada has been able to absorb". Wow!  If only there was someone out there in a position to see that coming and do something about it -- you know, a Prime Minister or something such. 

Epoch-eclipse now

Just five days to go for the arrival of the solar eclipse, which will be visible from western Mexico to eastern Canada on April 8. Weather permitting, it really should be a once-in-a-lifetime show, and the hype machines are gearing up accordingly.

My little town will be in the area of totality for just over three minutes near mid-afternoon. So will Niagara Falls, twenty minutes drive from us (though probably not on April 8), and in keeping with its over-the-top money-grabbing ethos, that little city is pulling out all the stops. The chief carnival barker, Mayor Jim Diodati, is telling everyone who will listen that he is expecting one million people to show up.

I'm not sure why Diodati or anyone else would imagine that watching it in Niagara Falls will somehow make the eclipse more exciting.  Plenty of other less glitzy towns in the area -- Buffalo, NY or Hamilton, ON for example -- will get exactly the same celestial show. It's also not clear how Diodati figures his city can accommodate anything like a million people. Have you ever been? Its permanent population is less than 90,000 and the tourist area, which is presumably where all the visitors will try to go, is really quite small -- basically it's a kilometre or two along the edge of the Niagara River, plus the incomparably tacky Clifton Hill, which makes the Las Vegas strip look like the Uffizi gallery. 

There are going to be extra trains to bring people down from Toronto, but this being Canada, there will only be three of them, and a quick back-of-the envelope calculation suggests they will be able to accommodate fewer than 10,000 people even with crush loads. So most of Diodati's million will be coming by car. At four persons per car, that suggests there will be 250,000 vehicles converging on the city. 

There's only one expressway to Niagara Falls, and it's busy at the best of times. Even for those who do make it into town, there is nowhere to park that many cars. And even if you do find parking, there is no way the tourist area can accommodate the people.  Total visitor numbers to the Canadian side of the Falls were about 13 million in 2022. That was a COVID year so the numbers may be higher now, but that equates to about 40,000 per day -- and as anyone who has ever visited can attest, the tourist area is always packed. 

Has Mayor Diodati though this through? What's your guess?  However, the very strong likelihood is that potential visitors have thought it through, and that many of them will think better of it, resulting in crowds that are just a fraction of the numbers Diodati is counting on.  That said, it's still going to be a zoo, and I won't be going any further than my south-facing driveway that day. 

UPDATE, 9 April: The first official estimate is that a total of 200,000 visitors took in the eclipse in the Niagara region, which is about 30 miles long. That's a far cry from Diodati's one million in Niagara Falls alone. There were maybe 100,000 in that city.  How many people were put off by Diodati's insane prediction?  Not that they missed much -- overcast skies across the area throughout the eclipse. And since I haven't stooped to this before, allow me to point out that an anagram of Diodati is "da idiot".

Canada's economy starts the year strong

Canada's economy has started 2024 on a remarkably strong note. Data released today by Statistics Canada show that real GDP grew 0.6 percent in January, the fastest monthly reading since January 2023.  The December GDP  data, originally reported as flat, were revised to a 0.1 percent decline, largely reflecting the impact of public sector strikes in Quebec, and January's strength partly reflects the end of those strikes. However, that was not the only important factor; growth in January was very broad-based, with eighteen of the twenty sub-sectors tracked by StatsCan recording higher output. 

Evidence that the strong report for January is not just a rebound effect is provided by the preliminary estimate for GDP growth for February. StatsCan estimates that real GDP grew a further 0.4 percent in the month, and once again the expansion appears to have been broad-based, with gains in extraction industries, manufacturing and finance. 

In short, although the economy only barely avoided a technical recession in the second half of 2023, prospects for the current year appear to be rather brighter than either both policymakers and business economists had been predicting. The Federal budget is set for April 16, and it will be interesting to see whether Finance Minister Freeland's fiscal projections are amended at all in light of the rise in revenues that faster GDP growth is likely to produce.  The stronger GDP data are also welcome news in the context of the falling per capita GDP that has resulted from high immigration rates.  Lastly, today's data arguably give the Bank of Canada more time to decide on when to start cutting interest rates, but a first move in June still seems the likeliest outcome. 

Bank of Canada goes political

It's customary for central banks to stay away from political issues as much as they possibly can, and the Bank of Canada is generally scrupulous about this.  However, there have been signs in recent times that the Bank is somewhat frustrated at the fact that its efforts to reduce inflation are being offset by the fiscal incontinence of PM Trudeau and Finance Minister Freeland.

Now, with the Federal budget a month away and an election likely in the next year or so, the Bank seems to be going quite a bit further. In a remarkable speech in Halifax NS today, Senior Deputy Governor Carolyn Rogers addressed "The Productivity Problem".  It has been well-known for many years that Canada's productivity performance is much worse than that of most other developed countries, with Italy the sole exception. Ms Rogers sees the solution in more focused education, better integration of skilled immigrants into the workforce, heightened competition and much higher business investment -- "In fact, investment levels have decreased over the past decade".

Objectively speaking, all of this is almost indisputable, but it is hard to argue that any of it falls within the remit of the Bank as it is generally understood.  It is almost inevitable that opposition leader Pierre Poilievre will seize on the Bank's analysis to further his pre-election campaigning, and it is hard to deny him the right to do so, given that he has already been making many of the same points himself. 

So what is the Bank up to?  It is unlikely that Trudeau and Freeland will be pleased at what Ms Rogers said. It is easy to pin the blame on a Government that has been in power for the better part of a decade -- note again the above quote about falling investment, and keep in mind that the government has seen fit to boost immigration to an extraordinary degree without even the semblance of a plan to help the newcomers to integrate and contribute. As for Poilievre, he has been a regular critic of the Bank, but it hardly seems likely that the Bank is now trying to ingratiate itself with him in case he gets elected.

All in all, it's a worthwhile speech that will justifiably trigger plenty of debate. The mystery is why it came from the Bank of Canada rather than one of the private-sector think tanks.  

FOMC: ever so slightly more dovish

In line with almost unanimous market expectations, the Federal Reserve today kept the Fed funds target range unchanged at 5.25 - 5.50%. The press release continues to describe inflation as elevated, but there is one significant change in the language: the FOMC now "judges that the risks to achieving its employment and inflation goals are moving into better balance". 

As ever, there is no clear hint as to when an easing cycle might begin. One key sentence carried over verbatim from the last press release suggests the Fed is still in no hurry: "The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent".  Given that headline CPI edged higher in February, and considering the steady upward pressure on global oil prices, it is no real surprise to find that market expectations for the extent and timing of rate cuts have been scaled back in recent weeks.  

The Fed has also released an updated Summary of Economic Projections.  Inflation (measured using the core PCE deflator) is not expected to fall al the way to the 2 percent target until 2025 at the earliest.  However, the closely-followed "dot plot" shows that about half of the participants in the FOMC still expect three 25 basis point rate cuts by the end of the year -- though, strikingly, two participants expect no reduction at all this year, and one does not even expect a cut in 2025.  

The takeaway from all this is that despite some softening in the Fed's language, a clear move toward easier policy is still some way away.  A rate cut at the June FOMC meeting, which until recently was the consensus expectation, now looks like the earliest possible timeframe for any sort of easing move. 

Canada CPI: more good news

Last week's US CPI report for February showed a small uptick in headline inflation, largely as a result of rising gasoline prices. It was generally expected that Canadian CPI would show the same pattern, but in the event, when the data were released this morning they showed a marginal slowing in the headline rate and generally encouraging trends in the special aggregates. 

Per Statistics Canada, headline CPI rose 2.8 percent year-on-year in February, down from 2.9 percent in January. The expert consensus had foreseen an uptick to 3.1 percent, largely because of higher gasoline prices.  Gas prices did indeed move higher in the month, but this was more than offset by lower prices in a variety of categories, including cell phone and internet services -- both notoriously expensive in Canada.  Even more welcome from a policy viewpoint, costs for food purchased from stores also moved lower, with the year-on-year increase of 2.4 percent falling below the headline inflation rate for the first time since October 2021. The only outsized sub-component of CPI is now the shelter index, which rose 6.5 percent from a year ago, reflecting both high mortgage interest costs and upward pressure on rents. 

Excluding the always volatile price of gasoline, CPI rose 2.9 percent from a year ago, down from 3.2 percent in January. All three of the Bank of Canada's preferred measures of core inflation edged lower in February, with their mean value now just above 3.1 percent.

Today's numbers certainly help to build the case for the Bank of Canada to contemplate rate cuts, but it remains unlikely that any move in that direction will come until the June 5 Governing Council meeting. Market expectations for rate cuts by the US Federal Reserve have been scaled back in the wake of last week's CPI data, something the Bank of Canada cannot ignore.  Moreover, it is likely that gasoline prices will push headline CPI higher in both March and April, not least because the Federal government will raise its despised carbon tax levy on April 1. The Governing Council meeting on April 10 may well echo the cautiously dovish tone seen earlier this month, but a rate cut at that time remains very unlikely. 

Hot and hot

North American markets and mass media have been full of speculation about the timing of central bank rate cuts for months.  After all, headline inflation readings have been heading lower for a year and more, with the target levels -- 2 percent for both the Fed and the Bank of Canada -- now coming into view.  Central bankers have warned -- largely in vain, it would seem -- that they need to see lower inflation being sustained before they can contemplate easing monetary policy.  The state of the two countries' job markets, both in terms of employment and wage growth, is evidently one of the indicators being followed most closely in both DC and Ottawa.

With that in mind we can turn to the February employment data for both countries, released before markets opened this morning. In the US, non-farm payrolls rose by 275,000, beating market expectations for a gain of 200,000.  That's a strong headline number, albeit partly offset by the fact that the previously-reported employment gains for December and January were revised lower by an aggregate of 165,000 jobs. 

Despite the headline strength, the details of the report convey a different impression: there is no real evidence that job market conditions are tightening.  The employment rate (i.e. the ratio of employment to population) edged lower in the month, while the unemployment rate ticked up to 3.9 percent.  Equally important, average hourly earnings rose only 0.1 percent in February, to stand 4.3 percent higher than a year earlier.  This may still be a little too high for the Fed's comfort, but it does not suggest that wages will be the factor that keeps inflation from falling to the target level in the months ahead.  

All in all, today's data suggest that the stars are coming into alignment for the Fed to star cutting rates some time this year.  However, the continuing resilience of the labour market means policymakers need not be in any hurry. A mid-year start to the rate cutting cycle, with about 75 basis points of easing by year-end, still seems the likeliest outcome.  

Turning to Canada, we find an equally hot, if not hotter headline number, but with some very different trends going on under the surface.  The economy added 40,700 jobs in February, following on from the 37,000 gain posted in January. Moreover, while the January figure largely reflected the addition of part-time positions, in February the economy created 71,000 full-time jobs in February.  Average hourly earnings rose 5.0 percent from a month earlier, slightly lower than the prior month's 5.3 percent gain but still too high for the Bank of Canada's comfort. 

Despite the headline strength, there are plenty of reasons for concern over Canada's employment outlook.  The unemployment rate continues to edge higher, reaching 5.8 percent in February, while the employment rate has now fallen for five consecutive months, something not seen since 2009.  The culprit here is the continuing massive rise in the labour force as a result of unprecedented immigration rates. The working-age population rose by 83,400 in February alone and has risen by 1,030,000 or 3.2 percent in the last twelve months.  It is just about inconceivable that the economy could ever produce jobs sufficiently quickly to keep pace with this,

Even Canadians who are pro-immigration -- a cohort includes your esteemed blogger, himself an immigrant -- are not sure exactly how this is going to pan out.  The Federal government seems equally at a loss, announcing vague plans to reduce immigration after 2026.  We have just learned that the Federal budget will be tabled in mid-April, and it seems likely that Finance Minister Chrystia Freeland will cite the immigration data as part of a case for still more public spending. Bank of Canada Governor Tiff Macklem has hinted in recent months that lax fiscal policy is making the Bank's job harder. The rate cutting cycle is still largely expected to start in June, but could a big-spending budget push that back?  We will soon find out. 

Bank of Canada: still on hold and no real hints

As expected, the Bank of Canada today kept its overnight rate target unchanged at 5.0 percent, while committing to maintain its existing policy of quantitative tightening.  Both the media release and the opening remarks delivered by Governor Tiff Macklem were evidently crafted to give away as little as possible about the timing of any future rate cuts. 

Governor Macklem began his remarks by stating that "In the six weeks since our January decision, there have been no big surprises". This is reflected in the wording of the media release. In terms of the global economy, the Bank says "Global economic growth slowed in the fourth quarter. US GDP growth also slowed but remained surprisingly robust and broad-based". As for the domestic situation, "In Canada, the economy grew in the fourth quarter by more than expected, although the pace remained weak and below potential.... Overall, the data point to an economy in modest excess supply".

The media release then moves on to the inflation picture and it is clear that he Bank does not think its inflation-busting work is done yet: "CPI inflation eased to 2.9% in January, as goods price inflation moderated further. Shelter price inflation remains elevated and is the biggest contributor to inflation. Underlying inflationary pressures persist: year-over-year and three-month measures of core inflation are in the 3% to 3.5% range.....The Bank continues to expect inflation to remain close to 3% during the first half of this year before gradually easing".

Given this assessment, the decision not to start cutting rates just yet is no surprise. The bulk of Governor Macklem's opening remarks focussed on fleshing out the Bank's logic: " the path back to our 2% target will be slow, and progress is likely to be uneven". Therefore, "It’s still too early to consider lowering the policy interest rate. Recent inflation data suggest monetary policy is working largely as expected. But future progress on inflation is expected to be gradual and uneven, and upside risks to inflation remain. Governing Council needs to see further and sustained easing in core inflation".

This leaves the timing of the start of a rate-cutting cycle completely vague, as is no doubt the Bank's intention.  However, it's worth remembering that Governor Macklem has said in the past that the Bank will not necessarily wait until CPI is all the way back to the 2 percent target before deciding to start lowering rates. The question now is how long does easing inflation have to be "sustained" before a rate cut is on the cards. It is unlikely that the Bank will feel it has enough evidence by the time of its next Governing Council meeting. set for April 10; the subsequent meeting on June 5 looks much more likely to produce a rate cut. 

With today's decision out of the way, attention can now urn to the next key data point: February's employment data, due for release on Friday. It is probable that the Bank had some notion of what that report contains when it made its decision today, but it was careful not to drop any hints. It is unlikely that the strong job gains seen in January will be repeated, but for now the real economy is holding up well enough to allow the Bank the luxury of time in making its policy decisions. 

Yes, we have no recession

Canada's GDP data for the final quarter of 2023 were released this morning, but you'd need to search the media pretty carefully to find out about it. That can only mean one thing, right? If you scroll WAAAY down into the CBC website, you will eventually find an article with this headline: "Canadian economy not in recession, but 2023 was one of its weakest recent years".  You can almost hear the editor yelling at the reporter when the data appeared -- "for Pete's sake find me something negative to say about this!" Luckily for the reporter, he/she did not have to look any further than the second paragraph of the data release to come up with that headline. 

If we look at that data release, we find that the economy grew 0.2 percent in Q4/2023, or just under 1.0 percent at an annualized rate, more than fully reversing the decline of 0.1 percent (0.5 percent annualized) reported in the prior quarter. Growth in Q4 largely reflected strength in external trade, with household spending also higher.  However, this was offset by weakness in investment, both business and housing, which is scarcely surprising with interest rates still at their highs for the current cycle.

In no way can this be considered a strong report, but yet again the economy has defied the strenuous efforts of the media to talk it into a recession. However, even as aggregate GDP continues to inch ahead, there is a story to be told about per capita GDP.  Canada's population expanded more than 2 percent in 2023 on the back of record-high immigration, so GDP per person is already declining.  With little likelihood of either significantly faster GDP growth or significantly lower population growth any time soon, that negative trend is set to continue. This is sure to be a major issue in the Federal election that is now probably no more than a year away.

As usual, StatsCan also released data on monthly GDP by industry alongside the quarterly numbers. Real GDP was unchanged in December from the previous month, with declines in goods-producing sectors offset by gains in services output. Two special factors may have pushed the aggregate figure for December lower: a public sector strike in Quebec, and unseasonably mild weather across much of the country, which reduced utilities output.  Interestingly, StatsCan's preliminary estimate for January suggests a healthy 0.4 percent gain in real GDP for the month, led by a strong gain in services output.

With today's report, the Bank of Canada now has all the key economic information it will use in making its next rate decision on March 6.  Even though inflation edged into the top half of the Bank's target range in January, there has been almost no market speculation about a rate cut at this session.  The GDP data do not change that in any way: with the economy still moving ahead, the Bank can afford to wait a little longer, in order to be sure that inflation can be brought sustainably back to its 2 percent goal.  

Within range

Remember when Canada's CPI data for December were released in mid-January?  The headline rate ticked up to 3.4 percent year-on-year, prompting hand-wringing in the media (and even, it should be said, by some professional economists who should have known better) on the basis that the data would prompt the Bank of Canada to delay interest rate cuts. The number was almost universally blamed on "higher gasoline prices", even though gas prices actually fell in the month; the real cause was a calculation anomaly related to the so-called "base effect", but it seems almost nobody could actually be bothered to figure that out. 

So, with past as prologue, today saw the release by StatsCan of CPI data for January.  On the surface the numbers look like good news: year-on-year headline CPI fell more than expected, dropping to 2.9 percent, just barely within the Bank of Canada's 1 - 3 percent target range.  And below the surface?  Well, guess what, that's mostly good news too.

Gasoline prices were once again a big part of the story, standing 4.0 percent lower than a year ago.  However, CPI excluding gasoline also slowed noticeably in the month, falling to 3.2 percent year-on-year from December's 3.5 percent reading.  Other special aggregates also showed a promising trend. Prices for food purchased from stores slowed to 3.4 percent from December's 4.7 percent.  CPI excluding food fell 0.1 percent in the month, dropping the yearly rate to 2.7 percent. The fastest-rising sub-component of the index continues to be shelter, which rose 6.2 percent from a year ago, but the month-on-month increase was a rather more modest 0.3 percent.

All three of the Bank of Canada's preferred measures of core inflation eased in the month.  Their mean value now stands at just below 3.4 percent, 0.3 percent lower than in December and markedly below the peak of near 5 percent seen early in 2023. 

This all looks very positive for the Bank of Canada, though it hardly warrants the renewed speculation in the media about early rate cuts: June still looks like the best bet for that.  And there is, as always, a possible fly in the ointment.  Gasoline prices have moved sharply higher in February, mainly courtesy of the Houthis. That could well mean that headline CPI ticks back above 3 percent for the month, no doubt triggering a fresh round of media angst, which can of course be safely ignored.

About those rate cuts....

The strong jobs data reported in Canada this morning -- strong at the headline level, at least -- seem likely to quell expectations that the Bank of Canada will make an early start on reversing its recent rate hikes. At the same time, there are plenty of issues behind the headline figure for the Bank to think about as it contemplates its future policy moves. 

According to Statistics Canada, employment rose by 37,000 in January, after being little changed over the three preceding months. As a result the unemployment rate, which had been rising gently through 2023 as a result of rapid growth in the population and the labour force, ticked down to 5.7 percent.  The year-on-year gain in wages edged down marginally from the previous month to stand at 5.3 percent, still too high for the Bank's comfort as it seeks to bring CPI back to the 2 percent target. 

On the face of it, today's numbers are incompatible both with the idea that the economy is on the brink of recession and with the belief that rate cuts must start soon. However, a look behind the headline numbers creates a somewhat more nuanced picture.  Most notably, full-time employment actually fell by almost 12,000 in the month, with the headline gain entirely the result of a rise of almost 49,000 in part-time positions.  Given the volatility of the monthly data, it is important not to read too much into this: over the past year, the economy has added 227,000 full-time jobs, as against 119,000 part-time.  Moreover, total hours worked rose 0.6 percent from the previous month, despite the preponderance of new part-time jobs. 

Despite the slight fall in the unemployment rate, it remains unclear that the economy can create jobs at a sufficient pace to keep up with population growth. Over the past twelve months,  the impressive gain of 345,000 new jobs is dwarfed by both the increase in population (just over 1,000,000) and the increase in the labour force (515,000).  The data for January are frankly puzzling: population surged by a further 125,000, but the labour force rose by only 18,000.  It seems certain that many more of the immigrants will soon enter the labour force, which will again start to exert upward pressure on the unemployment rate.  

Much for the Bank of Canada's policymakers to consider there, though there is enough strength in the data to give them time to think carefully about their next move.  And one other consideration may be coming back into play.  According to this article, the housing market in Toronto, by far the largest in Canada, is "roaring back to life", apparently partly driven by buyers anticipating the imminent arrival of lower interest rates.  Not what the Bank wants to see, and further evidence that the smart policy choice would be to wait until mid-year before starting to cut rates. 

The jobs keep coming

That darn struggling US economy just can't seem to stop creating jobs. Data this morning from the Bureau of Labor Statistics show that 353,000 new jobs were added in January, far ahead of expectations.  What's more, the initially-reported data for the two preceding months were revised higher by a total of 126,000. The unemployment rate held steady at 3.7 percent for the third month in a row. 

There can be no real doubt that Fed Chair Jay Powell had some advance knowledge of the data ahead of this week's FOMC meeting, so it is no surprise that he used his press conference to pour cold water on the notion that rate cuts could start as early as March. Looking beyond the headline figure, there is another element in today's release that serves to push rate cut expectations further into the future. Average hourly earnings rose sharply in January, up 0.6 from December, pushing the year-on-year increase to 4.5 percent from 4.1 percent previously.  This is clearly not compatible with the FOMC's wish to see inflation moving "sustainably" towards 2 percent before it contemplates rate cuts. 

Indeed, with the economy growing strongly and creating so many new jobs, why would the FOMC even consider risking an early rate cut, which could backfire by rekindling inflation expectations?  The economy clearly ain't broke, so there is little need to try to fix it. There are even signs that the US public is starting to take a somewhat less jaundiced view of the state of the economy, to which one can only say, what took you so long?

FOMC announcement: no change and no real hints

As expected, the US Federal Reserve today kept the funds target unchanged at 5.25-5.5 percent, while offering little in the way of guidance as to when any rate cuts might start to happen.  The Fed's view of the current state of the US economy is unchanged:

Recent indicators suggest that economic activity has been expanding at a solid pace. Job gains have moderated since early last year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated.

It is impossible to question any part of that summary. Indeed, the startling real growth rate reported for Q4 GDP makes "a solid pace" seem like an understatement.  Job growth continues to surprise to the upside, and the latest CPI data seem to confirm that the last stretch of getting inflation back to the 2 percent target is likely to prove the toughest. 

The uncertainty over inflation is clearly top of mind for the FOMC, which again reminds its audience that it "is strongly committed to returning inflation to its 2 percent objective".  The press release also includes a direct response to the media and market speculation over a possible early start to the easing process:  The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. 

That statement at least suggests they are starting to think about rate reductions, but remain far from being able to give any firm guidance as to timing. Given the state of the economy, it is hard to see why they need to be in any rush to cut.  The likeliest scenario continues to be one in which rates stay at the current level for the first half of this year, with the 75 basis points in reductions suggested by the most recent "dot plot" still in prospect by year-end.  

No recession is no news

At 8:30 EDT this morning, Statistics Canada released data for real GDP for November and, on a preliminary basis, December 2023. Half an hour or so later, I checked the website of the major news outlets to see how they were covering the release.  They pretty much weren't covering it at all, which could only mean one thing: the recession that the media have been baying for since about mid-2022 failed to show up yet again.

If we look at the actual data release, we find that real GDP grew 0.2 percent in the month of November, higher than the preliminary estimate of 0.1 percent,  after remaining virtually unchanged for the three preceding months.  The growth was broad-based, led by the goods-producing sectors, which posted a 0.6 percent month-on-month gain. Thirteen of the twenty sub-sectors tracked by StatsCan saw higher output in the month.  Moreover, StatsCan's preliminary estimate for December suggests that the economy accelerated further in the month, with real GDP posting a 0.3 percent increase.

These monthly numbers are calculated on a slightly different basis from the quarterly data and are of course subject to revision.  Even so, StatsCan feels able to offer an estimate for how the quarterly number for Q4, not due until February 28, is likely to turn out.  It estimates that real GDP grew 0.3 percent in the quarter, which annualizes to around 1.2-1.3 percent.  That would more than offset the 1.1 percent annualized decline reported for Q3. 

Even if these numbers are revised, it is clear that a recession has, yet again, failed to materialize -- indeed, the November and December data would appear to show that the economy is actually starting to move away from such an outcome. A check back with the major news outlets a few hours after the data were released showed they were at least deigning to report the figures, though not in large type and not without adding an editorial comment or two. The Toronto Star's story, for example, is headlined "The Canadian economy grew slightly in November".  In fact, the 0.2 percent gain reported for November annualizes to about 2.5 percent, in line with the economy's long-term potential, and December's 0.3 percent annualizes to a rate close to 4 percent, considerably above potential.  But that wouldn't be newsworthy, would it?

Bank of Canada: "we're getting there"

The Bank of Canada today kept its overnight rate target at 5 percent, in line with unanimous market expectations.  The press release is mostly a listing of factors that are starting to line up for eventual policy easing, followed by a brief  paragraph explaining why it's not yet time to make a move.  The Bank has also published an updated Monetary Policy Report today, and Governor Macklem's introductory remarks give more insight into how the Governing Council is currently thinking.

Let's start with the press release. After an opening paragraph that simply states the Bank's decision, we get two paragraphs on the global growth picture.  Key quotes: "While growth in the United States has been stronger than expected, it is anticipated to slow in 2024".  This is of course key for the Canadian economy and for policymakers, given the overwhelming importance of the US to Canada's external trade sector.  "The Bank now forecasts global GDP growth of 2½% in 2024 and 2¾% in 2025, following 2023’s 3% pace. With softer growth this year, inflation rates in most advanced economies are expected to come down slowly, reaching central bank targets in 2025". It is, of course, important for the Bank not to get its policy cycle too far out of line with the rest of the world, so the expectation that other central banks will soon be in a position to cut certainly makes its job easier. 

We then move on to two paragraphs on the domestic economy.  Key quotes: "the economy has stalled since the middle of 2023 and growth will likely remain close to zero through the first quarter of 2024....the economy now looks to be operating in modest excess supply.....However, wages are still rising around 4% to 5%". That final quote about wages is the first indication of the Bank's lingering concern that slower growth has not yet created conditions for lower interest rates. "Economic growth is expected to strengthen gradually around the middle of 2024.... Spending by governments contributes materially to growth through the year. Overall, the Bank forecasts GDP growth of 0.8% in 2024 and 2.4% in 2025, roughly unchanged from its October projection".  Once again we see the Bank complaining, albeit gently, that relentlessly expansionary fiscal policy is not making its job any easier. 

Finally we get a paragraph on inflation, explaining why it is still too soon to cut, even if the stars are coming into alignment. It's worth quoting the full paragraph:

"CPI inflation ended the year at 3.4%. Shelter costs remain the biggest contributor to above-target inflation. The Bank expects inflation to remain close to 3% during the first half of this year before gradually easing, returning to the 2% target in 2025. While the slowdown in demand is reducing price pressures in a broader number of CPI components and corporate pricing behaviour continues to normalize, core measures of inflation are not showing sustained declines". 

Shelter costs are at least partly under the Bank's direct influence because of the role played by mortgage costs, but it is arguable that rapid, immigration-driven population growth is a bigger factor. You might think that the statement that "core measures of inflation are not showing sustained declines" would lead the Bank to question whether the fall in headline CPI might not, in fact, have been brought about by Bank policy moves, and is instead mainly the result of supply chain normalization.  Needless to say, that's not how the Bank sees it. 

The final paragraph spells out what the Bank is looking for in the months ahead. "Governing Council wants to see further and sustained easing in core inflation and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour".

It's hard to judge from that just how close the Bank is to starting an easing cycle, but Governor Macklem's opening remarks are rather more explicit: 

"...monetary policy is working to relieve price pressures, and we need to stay the course. Inflation is coming down as higher interest rates restrain demand in the economy. But inflation is still too high, and underlying inflationary pressures persist. We need to give these higher rates time to do their work.

...with overall demand in the economy no longer running ahead of supply, Governing Council’s discussion of monetary policy is shifting from whether our policy rate is restrictive enough to restore price stability, to how long it needs to stay at the current level". 

Setting aside the Bank's apparent belief that it can claim all the credit for lower inflation, it's clear that these paragraphs continue the recent trend towards softer rhetoric about the rate outlook.  Monthly GDP data for December, due for release a week from today (i.e. January 31) should give a clearer reading on whether the economy has already slipped into a mild technical recession. If it has (and the guess here is that it hasn't, but it might be very close), calls for early rate cuts are certain to intensify.  The Bank is highly unlikely to respond, but the tone of today's releases suggests the easing cycle may start a bit earlier than previously seemed likely.  Waiting until June still makes good sense, but April can no longer be ruled out. 

A Lob-Law unto themselves

Back in the summer of 2023, the Canadian Government summoned the heads of the major grocery chains in Canada to a meeting in Ottawa, demanding that they do something to reduce the rate of food price inflation.  If we're naming names, there were five chains at the meeting -- three Canadian-owned (Loblaws, Metro and Sobey's) and two US-owned (Costco and Walmart).  

The pace of food price inflation has in fact fallen sharply since that first meeting, though there's no evidence that the pressure from the government had much to do with it. The Government has tried to keep the issue on the front pages, even going so far as to hint that it was trying to attract a foreign grocery chain into the Canadian market to increase the level of competition, a bizarre thing for any national government to do. It has also announced its intention to impose a legally-binding Code of Grocery Conduct on the existing quintet.

For the most part, the CEOs of the five firms have largely suffered through all this posturing in silence, with one exception. Loblaws CEO, the multi-billionaire Galen Weston, has been visibly angry about the whole process, blaming the rise in food prices during and after the pandemic mainly on the company's suppliers. He has also begun to warn that the Code of Grocery Conduct as currently propose will tend to push prices even higher, not lower them. 

This week we have found out why Galen can be so confident about this outcome. Loblaws has announced that it will be ending its current practice of cutting the prices of soon-to-expire food items -- bread. veggies, prepared meals and such -- by up to 50 percent in order to get them off the shelves. It portrays this deeply cynical move in an even more deeply cynical way, as providing "more consistency with our competitors".  I don't know about you, but I have generally thought that competition is supposed to help keep prices down, not provide cover for putting them up, but here we are.

As the linked article suggests, this looks a lot like collusion to a lot of people, although one of the quoted experts suggests it is "conscious parallelism" -- watching your competitors and imitating them.  Fair enough, but the timing of this, coming after all the meetings with the government and the threat of the Code of Grocery Conduct, looks very much like Loblaws flipping the bird at the government.  If Galen Weston actually wants a Piggly-Wiggly, or more likely an Aldi, across the street from one of his stores, he's going the right way about it.

UPDATE, January 20:  Well, here's a thing you don't see every day!  Loblaws has reversed its decision to eliminate the 50 percent discount as a result of the uproar its initial announcement caused.  Well done, Galen Weston, but next time, "measure twice, cut once".

Canada December CPI: nothing (much) to see here

Data released by Statistics Canada today show that headline consumer prices rose 3.4 percent in December from a year ago, after increases of 3.1 percent in the two preceding months. The uptick was largely expected by analysts, and reflects some slightly tricky quirks in the calculation, so pay attention at the back there.

The CBC website headlines its report on the data thus: "Gasoline prices help drive inflation up to 3.4 percent".  Except, guess what, gasoline prices actually fell in December, dropping 4.4 percent from the previous month.  The thing is, gas prices dropped even more sharply than that in December 2022, so what actually happened in December 2023 was an example of the so-called "base effect". The shift in the headline year-on-year number had more to do with what happened a year ago than with what is happening now.  Just to underline that point further, headline CPI (not seasonally adjusted) actually fell 0.3 percent month-on-month in December, a fact that does not seem to have registered with the headline writer. 

Stripping out gasoline prices, the inflation rate actually eased slightly in December, falling to 3.5 percent from the previous month's 3.6 percent reading. Shelter costs continue to exert upward influence on the overall price level, rising 6.0 percent from a year ago, led by a 7.7 percent increase in rents. The Bank of Canada's three preferred core inflation measures showed little change in the month, although one of the three, CPI-trim, edged slightly higher.

There is not much in today's data to change the Bank of Canada's thinking about the future course of interest rates. It remains the case that key measures of inflation are too far above the 2 percent target to allow for any early rate reductions, however enthusiastic markets may be about that prospect. The Bank's Survey of Consumer Expectations for Q4/2023, published on Monday, notes that Consumers perceive inflation to have decreased, and their expectations for price growth for some key goods such as food and gas have moderated.  That's obviously welcome news, except that the report goes on to say But near-term inflation expectations have barely changed, a fact that the Bank attributes to high expectations for inflation in services such as rents. As long as the economy keeps puttering along without slipping into recession, the Bank will likely prefer to hold off on rate cuts for much of this year. 

Not so fast!

It has been quite clear, at least to this blogger, that markets have been getting ahead of themselves in pricing in rate cuts by the US Federal Reserve.  December CPI data, released today by the Bureau of Labor Statistics, confirm that the Fed still has work to do. 

Headline CPI rose 0.3 percent in December as gasoline prices, which had been contributing to lower readings in recent months, showed little change.  The year-on-year increase ticked up to 3.4 percent in December from 3.1 percent in November.  Both the monthly and annual increases were in line with market expectations and are unlikely to have any major influence on the Fed's decision-making in the near term. 

Core inflation, however, is a different matter. CPI ex food and energy rose 0.3 percent in December, the same increase as in November.  This allowed the year-on-year rate to edge down to 3.9 percent in December from the previous reading of 4.0 percent.  This is the smallest increase in year-on-year core CPI since May 2021.  While that certainly counts as good news, it is still well above the Fed's inflation target, and the month-to-month changes, which annualize to almost 4 percent,  clearly suggest that core inflation is proving to be stickier than the headline measure. 

The Fed's regularly stated position that it will only start cutting rates when it is sure that inflation is heading sustainably back to the 2 percent target. The fact that the US economy still seems to be firing on all cylinders means that there is no need to start the cutting cycle prematurely, whatever the markets may think.  For now, the 75 basis points in cuts foreseen in the latest "dot plot" still seem like a reasonable projection, but the first cut is unlikely to arrive much before mid-year. 

December divergence

The first major data releases of the new year told differing stories about the state of the Canadian and US economies.  While employment growth in Canada has clearly slowed in response to the recent stagnation in real GDP, the US economy continues to add jobs at a rapid pace.  In both countries, however, continuing wage gains are likely to work against early rate cuts. 

In Canada, Statistics Canada reported that employment in December was almost unchanged from the previous month, with the net addition of a scant 100 jobs. (The significance of this can perhaps best be judged by noting that the standard error of the estimate is over 30,000)!  The report was in fact slightly weaker than the headline figure suggests, as a gain of 23,600 in part-time employment was offset by a loss of 23,500 full-time positions. Despite this, and somewhat perplexingly, total hours worked actually rose 0.4 percent in the month.

After rising steadily for much of the year, the unemployment rate was unchanged at 5.8 percent in December.  This can be entirely attributed to a sudden slowdown in the previously rapid growth in the labour force, which grew by only 4,800 in the month, well below the monthly average of 52,000 posted over the course of the year.  Given that the population grew by 74,000 in December, this is almost certainly only a temporary reprieve. 

The slowdown in employment growth will no doubt heighten expectations of early Bank of Canada rate cuts, but there is one key element of the data that will give the Bank pause. The year-on-year rise in hourly earnings rose to 5.4 percent in December from 4.8 percent in November. Given Canada's generally weak productivity performance, this seems way too high to ensure that headline inflation moves sustainably towards the Bank's 2 percent CPI target.  In the absence of a sudden severe turndown in the real economy, it remains likely that the rate cutting cycle will not begin much before mid-year. 

Turning then to the US, where opinion pollsters continue to report that voters are overwhelmingly dissatisfied with the state of the economy, we find that the economy added 216,000 jobs in December. This left the unemployment rate unchanged at 3.7 percent. There was a slight uptick in wage growth, with a 0.4 percent monthly gain pushing the year-on-year increase in hourly earnings up to 4.1 percent from the 4.0 percent rise reported for November. This is well above the latest rise in CPI, not that voters seem to have noticed. 

Unsurprisingly, while President Biden has welcomed the latest data ("a great year for American workers"), financial markets have been less impressed.  Even as inflation heads lower, the strong job gains and persistent strength in earnings make it likely that the Federal Reserve will opt to hold off on rate cuts.  There is simply no reason for the Fed to start cutting until it is completely sure that inflation is heading back to the 2 percent target.  The 75 basis points in rate cuts implied by the most recent "dot plot" may indeed materialize, but as in Canada, they are unlikely to start before mid-2024.