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.