Canada’s June employment report revealed a softening labour market. The unemployment rate increased by 0.2 percentage points to 6.4%, rising 1.4 percentage points since the start of last year. While this trend could support further easing by the Bank of Canada, the report also highlighted a significant concern: wage gains. Average hourly wages rose by 5.4% year-over-year. Although a weakening labour market typically suggests slower wage growth, this increase raises a caution flag for the Bank.
For the Bank to consider lowering its policy rate at this month’s meeting, a very low June CPI figure will be necessary. Even if the Bank does not cut rates this month, the softer labour market sets the stage for future easing. Overall, the data support further easing by the Bank, but the timing—whether in July or September—remains uncertain.
In the US, nonfarm payroll added 206,000 jobs in June, but significant downward revisions subtracted 111,000 jobs from April and May. The three-month average of monthly payroll gains dropped to 177,000 in Q2 from 267,000 in Q1. The US unemployment rate has risen 0.4 percentage points since the start of the year and 0.7 percentage points from the January 2023 low of 3.4%. Despite stronger-than-expected headline payroll gains, the overall employment report signals weakness, reinforcing the case for a September rate cut from the Fed.
Determining the timing of a Fed move has been challenging due to the stickiness of US inflation. The Fed’s preferred inflation measure, the core personal consumption expenditures (PCED), fell to 2.6% in May from 2.8% in April after peaking at 5.6% year-over-year in February 2022. The headline PCED also stood at 2.6% year-over-year in May.
The Fed revised its year-end projections at the June Federal Open Market Committee (FOMC) meeting, with their median forecast calling for the core PCED to finish the year at 2.8%, up from the 2.6% March projection.
In his June Q&A session, Fed Chair Jerome Powell noted the Fed’s awareness of base effects. Essentially, low monthly inflation numbers from the second half of last year will slowly phase out of the year-over-year readings, meaning that the new monthly inflation numbers will have to be even lower to maintain the current pace of disinflation.
What are the possible paths for U.S. inflation?
- Steady pace (2.8% core PCED by year-end): if core PCED maintains its current pace for the next seven months it would lead to a 2.8% year-end figure – an increase of 2.0% year-over-year. This is currently a lower probability outcome.
- Below pace (2.6% core PCED by year-end): a monthly inflation rate of 0.165% (2% annualized) would result in a core PCED of 2.6% by December. This is 0.2 percentage points below the Fed’s forecast and would potentially give room for a 25 basis point rate cut before the end of the year. This scenario could open the door for 2 to 3 rate cuts if inflation stabilizes around 2.6% year-over by year-end.
- Above pace (2.9% core PCED by year-end): a 0.2% month-over-month increase would push the core PCED to 2.9% by year-end. This scenario would require a significant geopolitical event like an oil price shock or global supply chain disruption that pushes up durable goods prices and brings inflation back to this higher trend level.
Shelter remains the primary obstacle in the final stages of this inflation unwind. Excluding rent prices, the core PCED has already reached the Fed’s 2.0% target. Housing inflation, currently at 5.5% in the PCED, is falling slowly as lagging rents tracked by the index catch up to market rates.
Recent research from the Federal Reserve of Boston highlights the challenge of bridging the gap in shelter prices. According to their findings, the difference between market rents and CPI shelter costs widened by 6 percentage points between December 2019 and March 2024. This discrepancy is projected to add approximately 0.7 percentage points to core CPI inflation and 0.3 percentage points to core PCED inflation.
Meanwhile, there has been notable downward pressure on goods inflation. Although prices for nondurable goods increased in May, durable goods prices, particularly autos and home furnishings, have been on the decline. This trend is primarily driven by reduced import prices from China. However, the potential escalation of a trade war and broader tariffs pose a significant threat to sustaining these cost savings from cheaper Chinese imports.
With all of these factors at play, the Fed has a challenging time ahead as it figures out when to cut rates.
Housing Affordability Watch
CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
Historically, Canada’s social housing policy has focused on keeping rents low to address income challenges, effectively substituting low rents for income support. While this strategy benefits low-income workers, it overlooks the revenue aspect of affordable housing and risks expanding supply without adequate maintenance, leading to an aging and poorly maintained housing stock.
In the latest Housing Affordability Watch, learn why relying solely on federal government programs for funding is unsustainable and how solving the revenue equation is crucial for the long-term development and sustainability of affordable housing. Read it here: Affordable Rental Housing: Solving the Revenue Equation
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