The Bank of Canada Outlook: Sticking to our guns for now

Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets. A podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.

Ali Jaffery: Welcome everyone to another episode of Eyes on the Economy. I’m Ali Jaffery, a Senior Economist here at CIBC. And joining me today is none other than our Chief Economist, Avery Shenfeld. Welcome, Avery.

Avery Shenfeld: Nice to be here.

Ali Jaffery: Today we’re going to talk about what is one of our favorite subjects, the Bank of Canada and what they’re going to do next. After the June cut, we were of the view that the bank would follow up with another quarter point move in July and then two further cuts beyond July to end the year. But now we’ve had two key reports since then, one showing an uptick in inflation and a second that added some color on Q2 GDP. So we’re going to explore how much that might impact a July rate decision and what other factors we need to watch to cement that call. So let’s start by jumping to the conclusion. After the inflation and GDP data, where are you now in terms of your earlier call for a July rate cut and two further cuts beyond that this year?

Avery Shenfeld: Admittedly, there’s a bit more uncertainty behind this call, but we’ve stuck with it and still view a July rate cut as more likely than not and two follow-up cuts to that. So we’re trying to forecast the broad direction of the wind, not every little twitch of the weathervane. And as a result, we still see the broad direction as supportive of those three additional cuts, including one in July.

Ali Jaffery: Okay, great. So turning to the CPI data, which saw the market reprice the July decision to essentially a 50-50 bet as of today, how disappointed should we be in terms of the uptick we saw in the May inflation reading?

Avery Shenfeld: It’s not what we wanted to see, but we do have to remember that these monthly data are volatile. And that’s why the Bank of Canada focuses in on three-month averages and year-over-year rates. And if we look at both the three-month moving average of the core numbers, as well as year-over-year rates, there really wasn’t that much damage to this thesis that inflation is moderating. Remember that we had some very low readings just ahead of this. And in particular, if we look at where inflation sits, excluding mortgage interest costs, it’s still basically running on the over the last year below the Bank of Canada’s 2% target. So I think it behooves us to remember that the bank does smooth these numbers out. And as long as the next reading is not problematic, I think we’re still very much in the territory that would be consistent with the July cut.

Ali Jaffery: Well, that brings me right to my next question. So what do you expect to see in the June inflation data? And where will that leave inflation tracking relative to what the Bank of Canada was projecting back in April?

Avery Shenfeld: There’s still grounds to believe that the next number is going to be back in the more friendly range of a 0.2 increase on those core measures. Remember that we’re starting from a position now where in the Bank of Canada’s view, as well as our own, there’s a bit of economic slack now. The way the bank words it is we’re in a state of excess supply. That should put some downward pressure on inflation. We have the global economy looking fairly soft, so there’s some downward pressure on global goods prices that should help out.And in general, that’s the kind of environment where you’d expect to be back in that 0.2 range. So I think the last month will end up looking like a bit of an outlier in a general trend that’s consistent with inflation moving to that 2% target.

Ali Jaffery: Okay, great. Now, what about the GDP data? You know, we saw that the GDP data for April was right on our forecast and also in line with the advance figures, but we also got the first advanced look at May’s monthly GDP. With that data in hand, how is Q2 shaping up? How does that compare with the Bank of Canada’s earlier projections? And what are the implications for the July interest rate decision of that data?

Avery Shenfeld: Well, given that these are monthly data and they’re not quite corresponding to the quarterly measures, it looks like GDP for Q2 is going to come in somewhere between one and a half and two percent. That may be a shade above what the Bank of Canada was forecasting for that quarter. But remember that they’re a miss on the other side with Q1 ending up being a bit of a disappointment to the Bank of Canada’s forecast. And so if we look broadly after all these revisions and adjustments, in level terms, GDP is actually looking like it’s going to end up a hair below what the Bank of Canada thought in Q2. And remember that we’ve also had some very strong population growth. We had expected population growth to be moderating in 2024. We now see that as more of a 2025 story. So to us, it’s still consistent with the economy growing at a pace where relative to population growth, if anything, maybe we’re adding a little bit to economic slack. And that’s consistent with what we’re seeing in the labor market indicators as well.

Ali Jaffery: Right. So other than the GDP data and the June CPI data, which is obviously very critical to the bank, what other news between now and late July could impact the Bank of Canada’s rate outlook?

Avery Shenfeld: We do have employment data coming up. I don’t really think those are as important as the CPI data. And we do have to remember once again that we could end up being surprised by a strong employment number that then lines up with also a strong population growth number. We could get surprises in both. I think the bottom line is we’re not expecting to see labor market slack diminish this month, as long as it stays where it is or even widens a bit further, that’s going to be consistent with the Bank of Canada needing to cut. So we’ll be eyeing both the employment numbers, but also things like the long-term unemployment rate, as well as the wage series. Even though we’re not big fans of it, we know the Bank of Canada does look at it. We like some of the other wage measures better. I think as long as those are reasonably temperate and not undoing the picture of labour market slack, again, we can stick with our call for a July rate cut.

Ali Jaffery: Okay, so given all of that Avery, where do you see opportunities in the fixed income market at this point?

Avery Shenfeld: Well, together with our colleagues in Fixed Strategy, when we look at both the Canadian and US bond markets, we’re a bit underpriced for near term rate cuts. In Canada, for example, the market’s thinking two cuts between here and the end of the year. Our call is for three. That does open up some room for the bond market to rally. In Canada, I think we’re leaning towards the 10 year part of the curve where we’ve had a bit of a sell-off on global supply fears, fears of big deficits. I think that there’s room for the 10-year part of the curve to rally in Canada between here and the end of the year and generate some reasonable returns. The US, maybe even the five-year part of the curve, because the market is really pricing in, I think, too high a longer-term resting point for the overnight rate. In other words, the neutral rate isn’t priced for where we think it is or where the Fed even thinks it is. And that should open up some room even for the five-year part of the US curve to rally as well. The one area that’s a bit more uncertain is 30s because the Canadian yields are fairly low. And also, we do have this issue about concerns about longer -term deficits impacting the term premium.

Ali Jaffery: We could go on and on about the bank and the bond market. So I think that’s a great place to wrap up. Thank you everyone for joining us on today’s episode of Eyes on the Economy.

Outro: Please join us next time on the Eyes on the Economy where we will share our latest perspectives and outlook for the Canadian and US economy.

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