The policy rate is now at the top of the estimated neutral rate range, 2.25% to 3.25%, with more moderate rate cuts continuing into next year. However, monetary policy remains restrictive, as the 3.25% policy rate is still 125 basis points above inflation, which has declined to roughly 2%, the Bank’s inflation target.

Economists have suggested that the tone of the central bank’s press release is more hawkish than before, unsurprising following two consecutive jumbo rate cuts. The Bank continues to say that its future decisions are data-dependent and will be impacted by policy measures taken by the government. In particular, the Bank highlighted the coming GST cuts, dispersal of bonus checks and the significant reduction in immigration. These developments have offsetting implications for inflation.

Governor Macklem signalled that he anticipated “a more gradual approach to monetary policy” in his press conference. We are forecasting 25 bp rate cuts through at least the first half of next year. That would take the overnight rate down to 2.5% by early June, a huge boost to housing that will likely enjoy a strong spring season.

Home sales recorded over Canadian MLS® Systems climbed 1.9% month-over-month in September 2024, reaching their highest level since July 2023. The Greater Toronto Area, Hamilton-Burlington, Montreal and Quebec City, Greater Vancouver and Victoria led the national increase.

“Sales gains are now three for three in the months following interest rate cuts, which is a trend even though the increases weren’t headline-grabbing,” said Shaun Cathcart, CREA’s Senior Economist. “That said, with the pace of rate cuts now expected to be much faster than previously thought, it’s possible some buyers may choose to hold off on a purchase for now. This could further boost the rebound expected in 2025 at the expense of the last few months of this year”.

Overall, the economy’s weakness continues to pull inflation down. However, price pressures in shelter and some other services are holding inflation up. Since the July Monetary Policy Report, the upward forces from prices for shelter and some other services have eased slightly. At the same time, the downward pressure from excess supply in the economy remains.

Tiff Macklem said today, “If inflation continues to ease broadly in line with the central bank’s July forecast, it is reasonable to expect further cuts in the policy rate. We will continue to assess the opposing forces on inflation and take our monetary policy decisions one at a time.”

The economy grew by 2.1% in the second quarter, led by government spending and business investment. This was slightly stronger than forecast in July. Together with the first quarter’s growth of 1.8%, the economy grew by about 2% over the first half of 2024. That’s a healthy rebound from our near-zero growth in the second half of 2023. The Bank’s July projection has growth strengthening further in the second half of this year. Recent indicators suggest there is some downside risk to this pickup. In particular, preliminary indicators suggest that economic activity was soft through June and July, and employment growth has stalled in recent months.

That makes this Friday’s Labour Force Survey data for August particularly important. We expect economic activity to slow in the third quarter to rough 1.3%, keeping the Bank in an easing posture through next year.

The unemployment rate has risen over the last year to 6.4% in June and July. The rise is concentrated in youth and newcomers to Canada, who find it more challenging to get a job. Business layoffs remain moderate, but hiring has been weak. The slack in the labour market is expected to slow wage growth, which remains elevated relative to productivity.

Turning to price pressures, CPI inflation eased further to 2.5% in July, and the central bank’s preferred measures of core inflation also moved lower. With the share of CPI components growing above 3% around its historical norm, there is little evidence of broad-based price pressures. But shelter price inflation is still too high. Despite some early signs of easing, it remains the most significant contributor to overall inflation. Inflation remains elevated in some other services but has declined sharply in manufacturing and goods prices.

As outlined in the Bank of Canada’s Monetary Policy Report, inflation is expected to ease further in the months ahead. It may bump up later in the year as base-year effects unwind, and there is a risk that the upward forces on inflation could be more potent than expected. At the same time, with inflation getting closer to the target, the central bank must increasingly guard against the risk that the economy is too weak and inflation falls too much. Judging from comments made at today’s press conference, the BoC is at least as concerned about too much disinflation–taking the economy into a deflationary spiral.

Macklem said, “We are determined to bring inflation down to the 2% target and keep it there. We care as much about inflation being below the target as we do about it being above it. The economy functions well when inflation is around 2%.”

With continued easing in broad inflationary pressures, the Governing Council reduced the policy interest rate by 25 basis points. Excess supply in the economy continues to put downward pressure on inflation, while price increases in shelter and some other services are holding inflation up. The Governing Council is carefully assessing these opposing forces on inflation. “Monetary policy decisions will be guided by incoming information and our assessment of their implications for the inflation outlook. The Bank remains resolute in its commitment to restoring price stability for Canadians”.

Monthly changes in sales activity were generally small amongst the larger centres in July. Interestingly, declines in Calgary and the Greater Toronto Area were offset mainly by gains in Edmonton and Hamilton-Burlington.

The Consumer Price Index (CPI) rose 2.7% year over year in June, down from a 2.9% gain in May. The deceleration was mainly due to slower year-over-year growth in gasoline prices, which rose 0.4% in June following a 5.6% increase in May. Excluding gasoline, the CPI rose 2.8% in June.

Lower prices for durable goods (-1.8%) y/y also contributed to the slowdown in the all-items CPI in June, following a 0.8% decline in May. An increase in prices for food purchased from stores (+2.1%) moderated the deceleration, as well as a smaller decline for cellular services in June (-12.8%) compared with May (-19.4%).

A Collective Sigh of Relief As The BoC Cut Rates For the First Time in 27 Months

With continued evidence that underlying inflation is easing, the Governing Council agreed that monetary policy no longer needs to be as restrictive. Recent data has increased our confidence that inflation will continue to move towards the 2% target. Nonetheless, risks to the inflation outlook remain. “Governing Council is closely watching the evolution of core inflation and remains particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

As shown in the second chart below, the nominal overnight rate remains 215 basis points above the current median CPI inflation rate, which shows how restrictive monetary policy remains. The average of this measure of real (inflation-adjusted) interest rates in the past 30 years is just 60 bps. The overnight rate is headed for 3.0% by the end of next year.

Bottom Line

There are four more policy decision meetings before the end of this year. It wouldn’t surprise me to see at least three more quarter-point rate cuts this year. While the overnight rate is likely headed for 3.0%, it will remain well above the pre-COVID overnight rate of 1.75% as inflation trends towards 2%+ rather than the sub-2% average in the decade before COVID-19.

Home sales activity recorded over Canadian MLS® Systems fell 1.7% between March and April 2024, a little below the average of the last ten years.

New Listings

The number of newly listed properties rose 2.8% month-over-month.

Slower sales amid more new listings resulted in a 6.5% jump in the overall number of properties on the market, reaching its highest level just before the onset of the COVID-19 pandemic. It was also one of the largest month-over-month gains, second only to those seen during the sharp market slowdown of early 2022.

“April 2023 was characterized by a surge of buyers re-entering a market with new listings at 20-year lows, whereas this spring thus far has been the opposite, with a healthier number of properties to choose from but less enthusiasm on the demand side,” said Shaun Cathcart, CREA’s Senior Economist.

The Bank also noted that Q4 GDP growth came in stronger than expected at 1.0% but was well below potential growth, confirming excess supply in the economy.

Employment continues to rise more slowly than population growth. During the press conference, Governor Macklem said it was too early to consider lowering rates as more time is needed to ensure inflation falls towards the 2% target.

The fourth quarter growth was fuelled by higher oil exports and was moderated by a significant decline in business investment. Housing investment declined again in Q4–a sixth decline in the last seven quarters. Despite increased activity in Q4 new residential construction and renovations, it was more than offset by a large drop in home ownership transfer costs, reflecting the weakening resale market across Canada. Single-family units and apartments led the rise in new construction, as all provinces and territories, except Prince Edward Island, post a rise in housing starts.

Investment in non-residential structures fell sharply, as did spending on machinery and equipment, especially on aircraft and other transportation equipment. Even government spending declined.

As the charts below show, monthly mortgage payments relative to after-tax income are far higher in Canada than in the US, even more so given the tax deductibility of mortgage interest and property taxes south of the border. The US economy grew by a whopping 5.2% in the third quarter compared to a decline of 1.1% in Canada.  Therefore, the Bank of Canada will likely cut interest rates sooner and more aggressively than in the US, improving housing affordability.