The Monetary Policy Report (MPR) detailed a slowdown in global economic growth “as past increases in policy rates and the recent surge in global bond yields weigh on demand.” Continued increases in longer-date bond yields reflect the stronger-than-expected growth in the US, where the Q3 economic growth rate, released tomorrow, is expected to be a whopping 5%. Ten-year yields in the US have risen to nearly 5%, boosting fixed mortgage rates in Canada.

Oil prices are higher than was assumed in the July MPR, and the war in Israel and Gaza is a new source of geopolitical uncertainty.

The Governing Council said that past increases in interest rates are slowing economic activity in Canada and relieving price pressures. “Consumption has been subdued, with softer demand for housing, durable goods and many services. Weaker demand and higher borrowing costs are weighing on business investment. The surge in Canada’s population is easing labour market pressures in some sectors while adding to housing demand and consumption. In the labour market, recent job gains have been below labour force growth, and job vacancies have continued to ease. However, the labour market remains on the tight side, and wage pressures persist. Overall, a range of indicators suggest that supply and demand in the economy are now approaching balance.”

Economic growth in Canada averaged 1% over the past year, and the Bank forecasts it will continue to be weak for the next year before increasing in late 2024 and through 2025. The Bank is not forecasting a recession over this period. “The near-term weakness in growth reflects both the broadening impact of past increases in interest rates and slower foreign demand. The subsequent pickup is driven by household spending as well as stronger exports and business investment in response to improving foreign demand. Spending by governments contributes materially to growth over the forecast horizon. Overall, the Bank expects the Canadian economy to grow by 1.2% this year, 0.9% in 2024 and 2.5% in 2025.”

In today’s MPR, CPI is expected to average about 3.5% through the middle of next year before gradually falling to the 2% target level in 2025. “Inflation returns to target about the same time as in the July projection, but the near-term path is higher because of energy prices and ongoing persistence in core inflation.”

The hawkish tone of the final paragraph of today’s press release is noteworthy. The Bank does not want to boost interest-sensitive spending, such as housing and durable goods purchases, by assuring markets that its next move will be a rate cut. Instead, the Bank said, “Governing Council is concerned that progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed. The Governing Council wants to see downward momentum in core inflation. It continues to be focused on the balance between demand and supply in the economy, inflation expectations, wage growth and corporate pricing behaviour. The Bank remains resolute in its commitment to restoring price stability for Canadians.”

Nothing was surprising in today’s report. The slowdown in economic activity since late last year has dramatically reduced excess demand. The output gap–the difference between the actual growth in GDP and its potential growth at full employment–is essentially closed, suggesting that demand pressures have been easing. They had previously expected the output gap to close in early 2024.

Of concern to the Bank is that inflation remains above their 2% target in the face of increased global risks of higher inflation. Upside risks to inflation include elevated inflation expectations of households and businesses, growing extreme weather events, and heightened geopolitical uncertainties including the Israel-Hamas war.

Price gains in energy and shelter — upward pressures on inflation — are “anticipated to be partially offset by the easing of excess demand, weaker pressure from input costs and further disinflation in globally traded goods,” the Bank said.

“Ongoing excess supply in the economy moderates price inflation, helps ease inflation expectations and encourages businesses to gradually return to more normal pricing behaviour.”

Canada’s households are more indebted, on average, than their US counterparts and their shorter-duration mortgages roll over faster. That makes the Canadian economy more sensitive to higher rates and is one reason the Bank of Canada first declared a pause in January, well before the US Federal Reserve. The central bank’s next decision is due Dec. 6, after two releases of jobs data, October inflation numbers and third-quarter gross domestic product figures. I expect the Bank to pause rate hikes for the next six to nine months. When they finally begin to ease monetary policy, they will do so gradually, taking the overnight rate down to roughly 4% by the end of next year.

The consumer price index increased 4.0% in August from one year ago, the fastest pace since April, after a 3.3% rise in July. That’s faster than the median estimate of 3.8% in a Bloomberg survey of economists. Monthly, the index rose 0.4%, double expectations. Excluding gasoline, the CPI rose 4.1% in August, matching the 4.1% increase in July.

Canadian inflation is no longer trending downward, presenting problems for the Bank of Canada. The BoC’s preferred 3-month core measure rose by a whole percentage point to 4.5%. The incoming data highlight the challenges in this phase of the inflation fight.

In addition to facing higher energy prices, Canadians paid more for rent and mortgage interest in August. Moderating the all-items CPI were declines in prices for travel-related services and a minor increase in food prices compared with the previous month.

The CPI was up 0.4% in August, following a 0.6% gain in July. The monthly slowdown was mainly driven by travel tours (-6.4%) and air transportation (-6.9%), as prices fell month over month following the peak of summer travel demand in July.

According to Bloomberg calculations, a three-month moving average of the measures that Governor Tiff Macklem has flagged as key to his team’s thinking rose by a full percentage point to an annualized pace of 4.49%.

The mortgage interest cost index also contributed to the acceleration in shelter prices, rising slightly faster in August (+30.9%) compared with July (+30.6%).

Although year-over-year price growth for groceries slowed in August, price levels remained elevated. On a year-over-year basis, prices for food purchased from stores rose 6.9% in August compared with an 8.5% increase in July.

Gasoline prices in September thus far have already risen to 10% above year-ago levels, so September inflation is likely also high. The additional problem for the Bank of Canada is that core inflation measures have also risen and will likely remain sticky on the high side. This has increased the odds of another rate hike this year.

Mitigating the Bank’s inflation concerns is the slowdown in economic activity. Employment growth has slowed as the jobless rate rose to 5.5% and job vacancies fell. Excess demand has also fallen. Financial strains in the household, financial and business sectors are emerging as delinquency rates on non-mortgage debt have soared. A pause in BoC rate hikes is warranted, but if the economy starts to pick up again or core inflation continues to hold steady or rise, additional rate hikes cannot be ruled out.

The national sales data were depressed in August by declines in Greater Vancouver and the Fraser Valley, Montreal, Ottawa, Hamilton-Burlington, London and St. Thomas.

The number of newly listed homes edged up 0.8% m/m in August, adding to the cumulative gain of more than 24% between March and July. New listings started 2023 at a 20-year low but are now closer to average levels. Recent survey data suggest pent-up supply is coming down the track as many homeowners reported they planned to their home in the next three years.

With sales falling and new listings edging up in August, the sales-to-new listings ratio eased to 56.2% compared to 59% in July and a peak of 67.4% in April. The measure is now closely aligned with its long-term average of 55.2%.

There were 3.4 months of inventory on a national basis at the end of August 2023, up from 3.2 months in July. While the measure is up a bit from its recent low of 3.1 months in May and June, it remains below the second half of 2022 and well below its long-term average of about five months.

The Aggregate Composite MLS® Home Price Index (HPI) edged up 0.4% on a month-over-month basis in August 2023— only about half as large as the July gain, which was only nearly half as large as the gains recorded in April, May, and June. This leveling off of prices aligns with slowing sales and a rebound in listings.

While prices are stabilizing at the national level, regional differences are re-emerging. Price growth has remained solid in Quebec and the East Coast, followed by British Columbia and the Prairies. Ontario is now a mixed bag, with some of the more significant increases and some of the bigger declines.

As of August 2023, the Aggregate Composite MLS® HPI was up 0.4% y/y. This was the first year-over-year increase since September 2022. Even though prices appear to be leveling out near current levels, year-over-year comparisons will likely continue to rise in the months ahead because of how prices continued to decline through the second half of 2022.

With the Bank of Canada moving to the sidelines and more supply gradually coming on board, housing activity will likely pick up in the coming months. Year-over-year home prices will rise owing to base effects, as lower prices were posted in the fall and winter of last year, making the y/y comparisons more favourable. We don’t want to see a burst of activity because that could cause the central bank to rethink its rate pause.

Housing affordability remains a significant problem for buyers, but recent data released for the second quarter shows an uptick in first-time purchases despite the affordability crunch.

The housing shortage and the resulting high cost of rent and buying are political issues at all levels of government. On Thursday, Prime Minister Trudeau pledged to cut the federal Goods and Services tax on constructing new apartment buildings as part of a promised host of measures to address affordability issues. Canadians are used to such actions by the feds, but the housing shortage will only worsen until municipalities address impediments to densification, building delays, and development costs.

The good news is that the July inflation data, released today, will likely keep the Bank of Canada on the sidelines as core inflation has finally begun to slow. A host of economic indicators also point to Q2 GDP growth–released September 1–slowing to around 1% following the stronger-than-expected 3.1% growth in the first quarter. Labour market tightening eased in July with the decline in employment, rise in unemployment and continued downtrend in job vacancies. The central bank also welcomes the slowdown in the housing market.

Home sales recorded over Canadian MLS® Systems posted a small 0.7% decline between June and July 2023. Activity has been showing signs of stabilizing since May. While sales increased in July in more than half of all local markets, a decline in the Greater Toronto Area (GTA) tipped the national figure slightly negative. Sales were also down in the Fraser Valley, which, together with the GTA, offset gains in Montreal, Edmonton and Calgary.

With new listings outperforming sales in July, the sales-to-new listings ratio eased to 59.2% compared to 63% in June and a recent peak of 68% in April. That said, the measure remains above the long-term average of 55.2%.

There were 3.2 months of inventory nationally at the end of July 2023, up slightly from 3.1 months in May and June.

While this was the first month-over-month increase since January, this measure is still a full month below where it was at the beginning of 2023 and almost two months below the long-term average for this measure (about five months).

The Aggregate Composite MLS® Home Price Index (HPI) climbed 1.1% month-over-month in July 2023—a larger-than-normal increase for a single month but only about half as large as the gains recorded in April, May, and June. This aligns with sales having leveled off as new listings have been recovering.

Despite the smaller gain at the national level, a monthly price increase between June and July was still observed in most local markets, as has been the case since April.

The Aggregate Composite MLS® HPI now sits just 1.5% below year-ago levels, the smallest decline since October 2022. Year-over-year comparisons will likely tip back into positive territory in the months ahead because prices continued to decline through the second half of 2022.

With interest stabilizing, housing activity will gradually increase as more supply comes onto the market. The Bank of Canada will likely cut rates in 25 bps increments by June next year. Without a doubt, that will be good news for the housing market.

There remains huge excess demand for housing due to the rapid population growth. While the federal and provincial governments are working hard to increase the supply of affordable housing, the process is painfully slow and is unlikely to come close to the demand for homes for purchase or rent for the foreseeable future.

The mortgage interest cost index (+30.6%) posted another record year-over-year gain and remained the most significant contributor to headline inflation. The all-items excluding mortgage interest cost index rose 2.4% in July.

The CPI rose 0.6% in July, following a 0.1% gain in June, mainly due to higher monthly prices for travel tours, with July being a peak travel month. On a seasonally adjusted monthly basis, the CPI rose 0.5%.

Food price inflation eased last month but remains sticky.​

The sizable slowdown in other economic indicators suggests that Q2 GDP growth slowed to roughly 1.0% in the second quarter–markedly below the 3.1% pace posted in Q1. Labour markets are also easing with a meaningful drop in job vacancies and a rising unemployment rate.

It is now likely that when the Bank of Canada meets again on September 6, the Governing Council will announce a pause in rate hikes. They will promise to remain ever vigilant, but there is a good chance that the overnight policy rate has peaked at 5%–up 1900% since March 2022.

We will unlikely see the first drop in the policy rate until June of next year. The Bank will proceed slowly, taking rates down by 25 bp increments. The low in the policy rate will probably be around 3%, well above the pre-pandemic level of 1.75%.

Wage inflation, however, re-accelerated, moving back to 5.0%. This, combined with the continued stickiness in core inflation, will keep interest rates high for longer.

July’s data follows a surprise gain of 59,900 in June and a 17,300 loss in May, showing that employment is a notoriously volatile series. Nevertheless, it provides the fodder for Macklem to pause again after two consecutive rate hikes.

The chances of a rate hike on September 6 have diminished significantly. However, more data is yet to come with July inflation on August 15 and the Q2 GDP figure on September 1.