August Inflation Hotter Than Expected

Canada’s inflation rate accelerated more than expected for the second consecutive month, mainly driven by higher gasoline prices. This will not be a one-month wonder as gasoline prices rose further in September. 

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.

Even more troubling was the rise in core inflation, which filters out components with extreme price fluctuations and is followed closely by the central bank. The so-called trim and median core rates also rose, averaging 4% from an upwardly revised 3.75% last month, exceeding the 3.7% pace expected by economists. 

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%.

Shelter prices were up 6.0% on a year-over-year basis in August after increasing 5.1% in July. The rent index led to faster shelter price growth, which rose 6.5% year over year nationally after a 5.5% gain in July. A higher interest rate environment may create barriers to homeownership and put upward pressure on the index. While rent prices accelerated in eight provinces, those with the fastest price growth were Newfoundland and Labrador (+8.4%), Alberta (+6.5%), Nova Scotia (+9.5%) and Manitoba (+6.1%).

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.

Bottom Line

Roughly 50% of the prices in the CPI are growing more than 5%, which is still very concerning for the Bank of Canada. Market rates moved up meaningfully on the news. With the 5-year government bond yield well above 4%, fixed mortgage rates will increase this week. The odds of another 25 bps rate hike this fall have risen, but there is still another employment report and the September CPI release before the next announcement date on October 25th. 

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.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

Home Sales Dipped Once Again Last Month In The Wake of Two Consecutive BoC Rate Hikes

Not surprisingly, buyers moved to the sidelines last month as the central bank took the overnight policy rate up to 5.0%. Home sales posted a 4.1% decline between July and August, well below the 10-year moving average shown in the chart below. However, on a year-over-year (y/y) basis, the number of transactions rose 5.3%. 

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.

New Listings 

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.

Home Prices

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.

Bottom Line

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.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

Following a marked decline in employment in July, Statistics Canada reported a gain of 40,000 net new jobs in August. Hiring increased in professional, scientific and technical services and construction and declined in educational services and manufacturing. Population growth outpaced the growth in net new employment, depressing the employment rate to 61.9%.

The unemployment rate in Canada was at 5.5% in August, unchanged from the 18-month high from the previous month and slightly below the market estimate of 5.6%. The data consolidated evidence of some softening in the Canadian labour market since the prior year, but the jobless rate remains well below pre-pandemic averages, and the labour market is tight compared to historical levels. Nevertheless, job vacancies are trending downward, and the ratio of unemployment to job vacancies is rising. 

Since the beginning of the year, average monthly employment gains are running at about 25,000, while the working age population is growing at 81,000. The surge in immigration warrants a larger than historically normal pace of job growth to maintain any given level of unemployment.

The Bank of Canada paused rate hikes last week saying that excess demand is falling. Today’s employment growth–though stronger than expected–is consistent with that point of view.

Policymakers will continue to scrutinize incoming economic data to determine if the current interest rates are sufficiently high to return inflation to 2%. They are particularly concerned about substantial wage gains, which perpetuate the wage-price spiralling. Today’s release showed year-over-year wage increases of 4.8%, only slightly below last month’s reading. But with the increasing number of new labour-market entrants, wage pressures are likely to diminish in coming months.

Bottom Line

The next BoC announcement date is October 25. There is another Labour Market Survey and two CPI reports before that date, but anecdotal evidence suggests that the economy is indeed slowing and we are near the end of the monetary tightening rate cycle.  

With last Friday’s publication of the anemic second-quarter GDP data, it was obvious that the Bank of Canada would refrain from raising rates at meeting on September 6, 2023. Economic activity declined by 0.2% in Q2; the first quarter growth estimate decreased from 3.1% to 2.6%.

The Bank of Canada’s press release on September 6, 2023 announced, “The Canadian economy has entered a period of weaker growth, which is needed to relieve price pressures.” The Q2 slowdown in output reflected a “marked weakening in consumption growth and a decline in housing activity, as well as the impact of wildfires in many regions of the country. Household credit growth slowed as the impact of higher rates restrained spending among a wider range of borrowers. Final domestic demand grew by 1% in the second quarter, supported by government spending and a boost to business investment. The tightness in the labour market has continued to ease gradually. However, wage growth has remained around 4% to 5%.”

Lest we get too comfy with a more dovish stance in monetary policy, the central bank warned that the Governing Council remains resolute in its commitment to restoring price stability.

Inflationary pressures remain broad-based. CPI inflation rose to 3.3% in July after falling to 2.8% in June. Much of the rise in July was caused by the statistical base effect. Nevertheless, current harbingers of inflation remain troubling. The increase in gasoline prices in August will boost inflation soon before easing again. “Year-over-year and three-month measures of core inflation are now running at about 3.5%, indicating little recent downward momentum in underlying inflation. The longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability.”

The Bank also continues to normalize its balance sheet by letting maturing bonds run off. This quantitative tightening keeps upward pressure on longer-term interest rates. 

Tiff Macklem and company concede that excess demand is diminishing and the labour markets are easing. The unemployment rate rose to 5.5% in July, up from a cycle low of 4.9%, and job vacancies continue to decline. Net exports have slowed, and the Chinese economy has weakened sharply. Consumers are tightening their belts as the saving rate rose and household spending slowed markedly in Q1. 

Monetary policy actions have a lagged effect on the economy. As mortgage renewals rise, peaking in 2026, the economic impact of higher interest rates will grow. Homeowners renewing mortgages this year are seeing roughly a doubling in interest rates. 

The Governing Council will focus on the movement in excess demand, inflation expectations, wage growth and corporate price decisions.

Bottom Line

The Bank of Canada, though independent, is coming under increasing political pressure. In an unusual move, the premiers of both BC and Ontario have publicly called for a cessation of rate hikes. Even so, the BoC is keeping its hawkish bias to avoid a bond rally that could trigger another boost in the housing market, similar to what we saw last April. The government bond yield is hovering just under 5%, having breached that level recently with the release of robust US economic data. 

There are two more meetings before the end of this year, and many are expecting another rate hike in one of those meetings. The odds of this are less than even, given the downward momentum in the economy.

The central bank’s next decision is due October 25, after two releases of jobs, inflation and retail data, gross domestic product numbers for July and an August estimate.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

The Canadian economy weakened surprisingly more in the second quarter than the market and the Bank of Canada expected. Real GDP edged downward by a 0.2% annual rate in Q2. The consensus was looking for a 1.2% rise. The modest decline followed a downwardly revised 2.6% growth pace in Q1. (Originally, Q1 growth was posted at 3.1%.) According to the latest monthly data, growth dipped by 0.2% in June, and the advance estimate for economic growth in July was essentially unchanged. This implies that the third quarter got off to a weak start. 

The Bank of Canada forecasted growth of 1.5% in Q2 and Q3 in its latest Monetary Policy Report released in July. The central bank is now justified in pausing interest rate hikes when it meets again on September 6th. Today’s report is consistent with the recent rise in unemployment. It suggests that excess demand is diminishing, even when accounting for such special dampening factors as the expansive wildfires and the BC port strike.

Some details of Q2 Growth

Housing investment fell 2.1% in Q2, the fifth consecutive quarterly decline, led by a sharp drop in new construction and renovations. No surprise, given the higher borrowing costs and lower demand for mortgage funds, as the BoC raised the overnight rate to 4.75% in Q2. Despite higher mortgage rates, home resale activity rose in Q2, posting the first increase since the last quarter of 2021.

Significantly, the growth in consumer spending slowed appreciably in Q2 and was revised downward in Q1.

Bottom Line

The weakness in today’s data release may be a harbinger of the peak in interest rates. Inflation is still an issue, but the 5% policy rate should be high enough to return inflation to its 2% target in the next year or so. As annual mortgage renewals peak in 2026, the increase in monthly payments will further slow economic activity and break the back of inflation. 

The Bank of Canada will be slow to ease monetary policy, cutting rates only gradually–likely beginning in the middle of next year. In the meantime, the central bank will continue to assert its determination to do whatever it takes to achieve sustained disinflationary forces. 

Today’s release of the US jobs report for August supports the view that the Canadian overnight rate has peaked at 5%. (The Canadian jobs report is due next Friday). Though the headline number of job gains in the US came in at a higher-than-expected 187,000, the unemployment rate rose to 3.8% as labour force participation picked up, growth in hourly wages was modest, and job gains in June and July were revised downward. 

In Canada, 5-year bond yields have fallen to 3.83%, well below their recent peak shown in the chart below.