Since 2021, Canada (and the world) has been grappling with a critical economic challenge: inflation. As one of the primary concerns for both policymakers and citizens, understanding its trajectory and implications is crucial. Things seem to be moderating so let’s look at the current state of inflation in Canada, its recent trends, and the potential impact on future interest rates. With the Bank of Canada at a pivotal juncture, we need to look at the intricacies of economic indicators, expert predictions, and the looming question of when and by how much interest rates might start to fall.

Inflation in Canada: A Closer Look

As of October 2023, Canada’s annual inflation rate stood at 3.1%, a notable decline from the 3.8% recorded in September 2023. This figure came in below the market expectations of 3.2%, signalling a more significant easing of inflation than anticipated. The primary driver of this decrease was a reduction in gasoline prices, a volatile but impactful component of the consumer price index​​​​.

Inflation Trends and Economic Impacts

The decline in inflation from September to October represents a continuation of the disinflation momentum we have experienced since spring. The annual average Consumer Price Index (CPI) in 2022 was 151.2, with a 12-month change in September 2023 of 3.8%. This decreasing trend is significant as it indicates a gradual relaxation of the price pressures that have been straining consumers and businesses alike​​.

Source: Trading Economics https://tradingeconomics.com/canada/inflation-cpi

Interestingly, the core inflation measures, which exclude the more volatile components like food and energy, also edged down. This points to a broad-based softening in price pressures, rather than isolated changes in specific sectors. Core inflation measures are crucial indicators for policymakers, as they offer a more stable view of the inflationary environment, free from the short-term volatilities that can skew the overall picture.

Bank of Canada’s Forecast

Despite the recent easing, the Bank of Canada had forecasted earlier that inflation would stay around 3.5% until the middle of 2024, eventually returning to the target of 2% in 2025. This is all part of the “higher for longer” talk we have been hearing lately. This projection indicates that while the path towards disinflation has commenced, the journey back to the Bank’s target inflation rate is expected to be gradual and steady​​.

The softening of inflation is a critical factor for the Bank of Canada as it shapes its monetary policy. The central bank uses interest rates as a primary tool to manage inflation – increasing rates to cool down an overheated economy and lowering them to stimulate spending and investment. The current trend of easing inflation opens up the conversation about the future trajectory of interest rates in Canada, a topic of significant interest to both the financial markets and the general public as we are waiting for rates to start falling.

Looking forward at Inflation

Inflation in Canada is finally starting to show a promising trend towards stabilization. The easing of inflation rates, combined with the Bank of Canada’s projections, suggests that the economy is moving towards a more balanced state. However, the path forward is not without its challenges and uncertainties, particularly in the context of global economic conditions and domestic factors like housing and employment markets. As we transition into discussing the potential impact on interest rates, it’s essential to consider these broader economic indicators and expert analyses to fully understand the landscape ahead.

The Economic Impact of Mortgage Renewals

A critical factor in the future direction of Canada’s monetary policy is the upcoming wave of mortgage renewals. Renowned economist David Rosenberg has underscored the significant influence these renewals will have on both individual households and the broader economy. He reminds us that about two-thirds of Canada’s mortgages by value are set to be renewed over the next three years. This impending situation could shift borrowers from the ultra-low rates experienced during the pandemic to significantly higher ones​​.

Rosenberg predicts that if rates remain at their current levels, the average monthly mortgage payment could see a staggering increase of 15% in 2024, escalating to 30% by 2025, and 45% by the end of 2026 as the lowest rates offered in 2021 renew. This surge in mortgage payments could lead to a 20% reduction in national disposable income by the end of 2026, a substantial hit to consumer demand and, consequently, the economy​​.

Policy Implications

Given these projections, Rosenberg anticipates that the Bank of Canada will need to cut its policy rate by 2 percentage points over the next 12 to 18 months, a move that could commence as early as the first quarter of 2024. This assertion is based on the belief that the central bank will need to act decisively to mitigate the financial strain on households and prevent a more severe economic downturn​​.

Bank of Canada’s Interest Rate Forecast

A recent Reuters poll of economists suggests that the Bank of Canada is likely at the end of its rate-hiking cycle, with the current rate at 5.00%. These experts predict that the central bank will hold this rate for at least the next six months, with a majority expecting a reduction in the second quarter of 2024. This forecast aligns with the signs of strain the Canadian economy is exhibiting from the significant rate hikes implemented since early 2022​​​​.

Source: Trading Economics https://tradingeconomics.com/canada/interest-rate

Recession Forecasts and Balancing Monetary Policy

While the latest business outlook survey from the Bank of Canada shows the weakest economic conditions since the COVID-19 pandemic, there is a divided opinion among economists regarding the likelihood of a recession. About one-third of economists surveyed predict an official recession, defined as two consecutive quarters of contracting economic output. This uncertainty in economic projections will play a crucial role in shaping the Bank of Canada’s decisions on interest rates in the near future​​​​.

The Bank of Canada faces a delicate balancing act. On the one hand, it needs to ensure that inflation returns to its target without causing excessive economic contraction. On the other, it must consider the impact of high interest rates on heavily indebted households and the broader economy. This situation requires careful calibration of monetary policy, considering both short-term needs and long-term economic stability​​.

Conclusion

The landscape of Canada’s economy and monetary policy is at a pivotal point. With inflation showing signs of easing and the impact of mortgage renewals looming large, the Bank of Canada’s next steps will be critical. While the central bank’s current stance is towards maintaining the interest rate at 5.00%, the pressure from various economic factors, including a potential increase in mortgage payments and the risk of a recession, could prompt a change in this policy.

The consensus among experts suggests a likely reduction in interest rates by the second quarter of 2024, a move that would align with the broader goal of stabilizing the economy and returning inflation to its target. However, the exact trajectory will depend on a multitude of factors, including global economic conditions, domestic economic indicators, and the evolving financial landscape.

As we move into 2024, the decisions made by the Bank of Canada will not only influence the economic well-being of the country but also set a precedent for how central banks can navigate the complex interplay of inflation control, economic growth, and financial stability in a post-pandemic world.