Canada is experiencing the economic slowdown that economists have long predicted, potentially signaling the conclusion of the Bank of Canada’s remarkable series of rate hikes. Several factors, including stagnant growth, a rising unemployment rate, sluggish retail sales, and a deceleration in inflation, are likely to lead to Governor Tiff Macklem and the governing council keeping the benchmark overnight rate at 5% unchanged when they announce their decision on Wednesday.
Despite these economic challenges, it’s improbable that officials will announce an end to their policy adjustments. The future path of inflation remains uncertain, and surveys suggest that both consumers and businesses anticipate continued elevated inflation rates. Notably, core inflation measurements, which exclude volatile items like gasoline, remain above 3.5%.
Macklem is unlikely to take actions that would restrict the central bank’s ability to raise borrowing costs in the future if necessary. As Carrie Freestone, an economist at the Royal Bank of Canada, points out, “Monetary policy is likely sufficiently restrictive, but I don’t think the Bank of Canada will explicitly state that they are finished hiking because they want to leave the option on the table if they need to go ahead with a hike later on.”
Macklem’s primary responsibility is to outline the timeline and strategy for bringing down the current inflation rate of 3.8% (as of September) to the 2% target. The central bank will provide updated forecasts in an accompanying monetary policy report, which is expected to discuss the headwinds facing consumers who are curbing their spending due to the highest borrowing costs in decades.
Charles St. Arnaud, chief economist at Alberta Central, believes that watching from the sidelines is the appropriate approach. His research indicates that economic downturns in Canada typically start five to seven quarters after interest rates reach a level that restricts growth, a threshold that he believes was reached in the fourth quarter of 2022. This aligns with the consensus forecasts of very slow growth, with GDP expected to expand at an average annualized rate of 0.2% over the next three quarters, following an unexpected contraction between April and June.
Despite the mounting risk of a recession, Macklem and the rate-setting council members are likely to emphasize that a more accommodative monetary policy remains a distant prospect. Overnight swap markets also appear to concur, with low odds of either a rate increase or a rate cut until next summer. In contrast, economists are more cautious, forecasting potential rate cuts starting in the second quarter of the following year, according to a Bloomberg survey’s median forecast.
Long-term bond yields have risen significantly, contributing to tighter financial conditions, with Canada’s 10-year yield surpassing 4%, and mortgage rates on the rise. The Bank of Canada acknowledges the impact of these long-term bond yield increases and suggests they will be a factor in their decisions.
Given that Canadian households are more indebted on average compared to their U.S. counterparts and have shorter-duration mortgages, they are more vulnerable to higher rates. This factor influenced the Bank of Canada’s decision to pause in January, well ahead of the U.S. Federal Reserve.
Canada’s labor market, although adding jobs and maintaining a 5.5% unemployment rate for three months, is showing signs of slowing labor demand and reduced job vacancies.
Despite these challenges, Macklem’s primary mandate is to achieve 2% inflation. In July, the bank’s forecast indicated that this target might not be reached until mid-2025, providing a reason to keep the possibility of tighter monetary policy on the table, even in a weaker economic environment. As Andrew Kelvin, chief Canada strategist at Toronto-Dominion Bank’s securities unit, notes, “If they ultimately wind up allowing inflation expectations to come unanchored because they under-tightened, I think that makes their job quite a bit more difficult in the future.”
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Author Faith Yakubu 
