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The “last mile” of the inflation target, similar to the U.S., will be the hardest to conquer for the Bank of Canada, largely due to sticky services inflation. Given progress on the inflation fight and below-trend growth, we expect the Bank of Canada (BOC) to cut its policy rate target by an additional 25 to 50 basis points this year, ending the year between 4.25% and 4.5%. We see unemployment in Canada hovering between 6.0% and 6.5% throughout the year, as wage growth continues along a more moderate path.
A weaker labour market and a resulting easing of wage pressures should slow price increases for services unrelated to shelter. As Figure 1 shows, since Q4 2023, core CPI has been on a downward trend even as price growth for services has been rising slowly. Prices for goods have risen 1% on a year-over-year basis as of May, and faster price growth for services was fueled by travel tours, rent, cellular services, and air transportation. Rents over the last 12 months rose by 8.9% largely due to population growth and higher interest rates.
The pace of CPI growth rose to 2.9%, year-over-year in May, up from a 2.7% gain in April. This dampened expectations for another 25-basis-point reduction by the BOC in July. We foresee continued progress in the inflation fight amid below-trend growth and restrictive monetary policy. High mortgage interest costs should start to fall with further decreases in the BOC policy rate, as mortgage costs account for almost 20% of the average Canadian’s income, which is a record high.
Canada’s GDP grew by 1.7% in the first quarter, driven by a rise in household spending, particularly on services. The household savings rate was 6.9%, the highest rate since the first quarter of 2022, as consumers delayed spending on goods in anticipation of possibly higher mortgage costs and rents. However, real GDP per capita, which accounts for Canada’s rapidly growing population, declined again during the quarter. It was the sixth decline in the last seven quarters.
Canada’s economic growth remains below its pre-pandemic trend. Restrictive monetary policy intended to fight inflation constrained activity, leaving Canadian GDP growth well below potential. However, with the BOC having started a policy-easing cycle, we anticipate that the output gap could remain around 4% at year-end 2024, as you can see in Figure 2.
We expect below-trend growth for Canada in 2024, as consumers feel the impact of higher monetary policy. This is a significant factor for Canadian homeowners due to the greater use of variable rate-mortgages versus other regions which have longer-term fixed mortgage rates, like the U.S.
Given progress on the inflation fight and below-trend economic growth, the BOC on June 5 became one of the first developed markets’ central banks to cut rates, decreasing its overnight rate target by 25 basis points, to 4.75%. We expect the BOC to cut its policy rate target by an additional 25 to 50 basis points later this year.
Bank of Canada governor Tiff Macklem mentioned on June 24 that he will be “looking for wage growth to moderate further” but also suggested that the bank is focusing on certain measures of wage growth that have slowed more than the overall rate. He also mentioned that the economy appears on track for a soft landing, opening the path for further rate cuts.
As inflation continues its progress, growth sustainability should become more important, particularly as mortgage renewals will take place against some of the lowest rates in history five years prior. That coupled with tighter immigration policy that could weigh on consumer growth.
All these aspects make us optimistic about the likelihood of further rate cuts in 2024.
Labor markets continue to loosen as the unemployment rate has steadily risen to 6.2% from the trough of 4.8% in July of 2022 and 5.7% in January. Job vacancies, which measure the number of open positions among Canadian employers, fell to a little over 575,000, which is 28% drop from April 2023. There are 2.3 people unemployed for each job vacancy.
After the April hiring surge, which was largely driven by increases in part-time and service sector workers, the labour market geared down in May. A labour market gain of 27,000 workers was driven entirely by 62,000 new part-time jobs as full-time employment declined by 36,000.
The unemployment rate is within our target range of 6.0% to 6.5%, and we expect it to hover around that range for the rest of the year. Wage growth has moderated to around 5% year over year but remains well above its pre-pandemic average of 2.25%.
Ashish Dewan CFA, CFP is Investment Strategist at Vanguard Investments Canada.
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