Canadian Economy In “Modest Excess Supply,” Higher Rates Need Time: Bank of Canada

Canada’s economy went from mass shortages to excess in roughly zero-to-five. The Bank of Canada (BoC) announced a widely expected hold for its key interest rate this morning. There are encouraging signs when it comes to moderating inflation, and in their opinion more time at these levels will help bring it back to their target rate. The central bank believes the economy has reached the point of “modest excess supply,” which will slow growth for everything from prices to wages. 

Bank of Canada Says Monetary Policy Is Working But Needs More Time

Canada’s central bank held its key interest rate at 5.0% this morning. The BoC also reiterated it would continue its policy of quantitative ease, helping to firm bond yields. The general consensus remains that the economy continues to weaken, and inflation is coming down. However, the Governor sounded more cautious about upside risks than he did just a few weeks ago. 

“…with inflation still close to 3% and underlying inflationary pressures persisting, the assessment of the Governing Council is that we need to give higher rates more time to do their work,” said BoC Governor Tiff Macklem. 

“Demand pressures have eased, and the economy now looks to be in modest excess supply.”

Canadian Economy Now Has An Excess of Everything, From Labor To Goods

Excess supply. That was the base observation present in virtually all of the economic factors the Governor discussed, from economic growth to wages and most importantly—its influence on inflation.  

The BoC made note of real GDP drastically outperforming their forecast in the January outlook. While Q4 demonstrated an economy doing significantly better than expected, they were quick to point out the growth in the second half of 2023 was still nearly zero. A big concern, especially considering rapid population growth. 

Speaking of rapid population growth and a weak economy, labor markets are moving as expected. “With employment growing more slowly than population, the labor market has come into better balance,” said Gov Macklem. 

In other words, an excess supply in labor is starting to ease wage pressure. They specifically note that job vacancies are now better in line with historical levels, and while wages are still showing annual growth of nearly 5% at last check, the oversupply in labor is likely to curb that as employers observe the uptick. 

Inflation Progress Is Slow But Steady, Rate Cuts May Take Longer

A slowing economy means slowing demand, and that’s helping to bring CPI closer to target. Headline CPI eased to 2.9%, within the tolerance range of the central bank’s target.  

Despite slowing headline inflation, the BoC is still concerned. The Governor stated concerns that headline CPI was primarily influenced by volatile energy and food prices. When examining CPI Core, their preferred measure that trims volatile components, inflation remains significantly above target. 

“Our preferred measures of core inflation eased in January but remain above 3% on a year-over-year and three-month basis. As well, the share of CPI components rising faster than 3% declined but is still above the historical average,” explained the Governor. 

Adding, “In other words, the path back to our 2% target will be slow, and progress is likely to be uneven.” 

The BoC forecasts have notoriously underestimated inflation targets over the past few years. For those that think they’ll finally get it right, they expect CPI Core to reach the 3% range by mid-year, leaving price growth 50% higher than their target rate. Not particularly encouraging news for those looking for rate cuts, but the Governor may be overcompensating for hinting at easing policy at the prior announcement.

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