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Parsing the Bank of Canada’s Messaging

25 March 2024

February headline inflation came in below expectations at 2.8%. Core inflation, captured by the Bank’s preferred CPI-median and CPI-trim measures, also fell short of expectations, at 3.1% and 3.2% respectively.  Some commentators have suggested that the Bank of Canada should declare victory and start cutting rates in April. They argue either that the Bank should look through the housing-related components of inflation or that core inflation measures overlook important aspects of the distribution of price changes. 

Typically, the Bank doesn’t explicitly indicate when its next policy move will be, particularly if that move involves a change in direction. Instead, it will offer insight into the key factors influencing its policy setting decision. These factors encompass corporate price setting, wage pressure, the relationship between housing and inflation, and inflation measurement.

The Bank of Canada is concerned about corporations leveraging their market power to boost profit margins during this inflationary period. However, current data paint a different picture: Corporate profits are under pressure and have fallen to below-normal levels relative to GDP as gains in the resources sector have waned. The Bank’s research shows that businesses increased markups in 2020, but mainly because of rising costs. While there was some increase in markups in 2021, it contributed only marginally to inflation.

Business confidence remains downbeat. The Bank of Canada’s Business Outlook Survey (BOS) indicator registered at -3.15 in Q4 of 2023, up slightly from the post-pandemic low of -3.45 in Q3 2023. Fewer firms reported feeling pressure to raise wages due to cost-of-living adjustments or retention concerns. The one negative note, from an inflationary perspective, is that businesses anticipate higher-than-average wage adjustments over the next 12 months, with roughly three-quarters of firms expecting wage growth to normalize by 2025. This pressure on wages initially stemmed from the challenge of filling the high number of job vacancies post-pandemic, followed by organized labor catching up on real wages as inflation surged.

The upcoming release of the Survey of Employment, Payrolls and Hours (SEPH) for January, scheduled for March 28, will provide valuable insight into the decline in job vacancies, which are currently running about 25% below year-ago levels. It will also indicate whether there is any sustained decline in wage growth.  The Bank of Canada noted in its March policy statement that there are “some signs that wage pressures may be easing.” It specifically highlighted that wage growth in the payroll employment data is about 2 percentage points below the 5% plus growth seen in the labour force survey data in Q4 of last year. If this differential continues, it will reassure the Bank that wage pressures are more in line with its target levels for inflation. 

The mortgage interest cost in the February CPI rose by 26.3% year-over-year. Several commentators have suggested the Bank should look past this inflation component when setting policy, attributing increased mortgage costs to higher interest rates resulting from tighter monetary policy. The Bank’s governing council acknowledged that “if mortgage interest costs were the only component holding up inflation, there could be some capacity to look through them, so as not to unduly restrain economic activity to get headline inflation back to 2%.” However, the council concluded that this was not the current situation.

The Bank’s governing council discussions emphasize that underlying inflation isn’t gauged by a single statistic but by a collection of indicators. These indicators include core inflation measures, including the Bank’s preferred metrics—CPI-trim and CPI-median—as well as others that exclude volatile components, such as CPI excluding food and energy. Additionally, they consider the distribution of inflation rates across various components of the CPI basket.

Desjardins Financial believes that the current core inflation measures, CPI-trim and CPI-median, “have become biased, probably overestimating the actual underlying inflation rate.” They argue that the present distribution of price changes is imbalanced. Once this skew is adjusted, core inflation falls below 3 percent.

I expect that the Bank is aware of this concern. During the January Monetary Policy Report press conference, Governor Macklem remarked that underlying inflation “is more of a concept than a measure” and noted the Bank was also looking at CPIX (CPI excluding mortgage costs) and CPI excluding food and energy.

CPIX excludes the eight most volatile components of the Consumer Price Index (CPI) and adjusts the remaining components for the effects of indirect taxes. Among the excluded components are food, energy and mortgage interest costs. According to a recent report by CIBC, using a method developed at the Federal Reserve Bank of San Francisco, CPIX is “responding to the weakening in Canadian domestic demand of late, and not simply easing due to other forces that could dissipate.” Their view is that wage inflation remains a concern.

To predict the Bank’s next steps, pay attention to their commentary on wage pressures and their overall interpretation of core inflation. The upcoming April statement will feature a fresh economic forecast, including estimates of potential growth and the neutral rate of interest. If February’s inflation progress persists and indications of wage pressure relief emerge, the Bank may shift the tone of their discussion to signal a rate cut in June.

Housing Affordability Watch

CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis

A recent report by Frank Clayton of Toronto Metropolitan University scrutinizes the disparity in housing affordability between Ontario’s two largest metropolitan areas, Toronto and Ottawa. Despite similar circumstances in the mid-1980s, Toronto now exhibits a significant affordability gap, with median-income households spending nearly double their income share to purchase an average priced home compared to Ottawa. Clayton attributes this gap to municipal fragmentation, additional planning layers imposed by the province, and stringent land-use regulations.

Against this backdrop, we examine the costly impact of overly strict land-use regulations, the benefits of implementing less restrictive policies, and the potential for concrete action by Canada’s housing regulator, CMHC, to achieve these benefits.

Read the full article here: A Tale of Two Cities


Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.

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